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BoE Super Thursday to live up to its name

Surely they won’t bottle it again, right?

Super Thursday promises to live up to its name one way or another this week, as the Bank of England either raises interest rates to post-financial crisis highs or risks causing unnecessary and significant market volatility.

  • Rate hike priced in but not guaranteed
  • Possible scenarios on Thursday
  • Key things to look out for

It’s been an unusual lead up to a central bank meeting, in that despite a lack of clear and specific warning signals, the likes of which we’ve become accustomed to, investors have become absolutely convinced it’s happening.

In fact, markets are now pricing in almost a 90% chance that the Monetary Policy Committee will vote to hike rates on Thursday. If the central bank doesn’t hike now, it will need a very good excuse and even then, this entire process of forward guidance will once again be heavily criticized.

BoE Interest Rate Probabilities

Source – Thomson Reuters Eikon

While it may not make much sense to blame the central bank when I’ve earlier stated that there’s been a lack of clear and specific warning signals, but policy makers are very aware of what market expectations are and when they deviate in such a significant way from reality, they do something about it. This time they have not.

This is where assumptions come into it. The lack of alternative guidance from policy makers has actually fuelled expectations that they must be planning a rate hike or they would have otherwise intervened to realign expectations.

Head fake or breakthrough ??

Remember, investors are always looking for subtle hints in order to get ahead of the curve and in this case, the central bank’s silence has been deafening. Or so investors hope. Should the MPC not deviate much from last month’s vote and hold off again, there could be a sizeable response in the markets, particularly in the pound and short-term UK debt.

Whichever way the central bank goes – and just to be clear, I think they will raise rates – there could be a very interesting response in the markets. These are some of the possible outcomes.

Dovish hike

In this scenario, it would be natural to think that this would be bullish for the pound and, in the immediate aftermath it could be. But if markets are already largely pricing this in then what exactly is left?

A rate hike that is accompanied by dovish language and cautious approach on the economy, or even wait and see approach to Brexit negotiations, could quickly trigger some profit taking by those who have anticipated such a move prior to the meeting and be bearish for the pound not long after the announcement.

EURGBP Daily Chart

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Hawkish hike

This is probably the most bullish feasible outcome for the pound. In this scenario, the BoE raises interest rates and warns that more will follow, maybe even a couple by the end of next year (more is of course possible but maybe not realistic given how the economy is right now and the uncertainty linked to Brexit).

In this case, the BoE is likely opting to look through Brexit or using base case assumptions on it – due to the sheer number of unknowns still – and base its views purely on the economic data, some of which is very good (unemployment, job openings, inflation) and some of which isn’t great (wages, investment, household debt).

GBPUSD Daily Chart

No hike

I don’t think this is likely (although it is arguably what the central bank should be doing) but it’s possible. Under this scenario, the central bank takes all of the recent data into consideration and takes the view that, given the uncertain outcome of Brexit negotiations and possibility of no deal, it makes more sense to wait until November to raise rates.

A few months is not a long time to wait but by then, they should be a lot better positioned to judge what the outcome of Brexit negotiations will be and whether it’s risky or not to be raising rates in such an environment, or what the chance is that it will be reversing course in the near-future, to its own embarrassment.

Of course, the argument against this is that there has been no noise coming from the central bank that market expectations are out of sync with their own which is usually a reliable sign that they are not.

GBPCAD Daily Chart

What to look out for

All things considered, a rate hike looks likely but there is going to be a number of elements of tomorrow’s event that will influence how markets respond.

Fed decision and US labour market in focus

The interest rate decision is the most obvious (12pm UK time) but alongside the release, we’ll get the minutes from the meeting, voting and the inflation report which contains new growth and inflation forecasts for the coming years, which will effectively determine how many hikes we’ll see.

This will then be followed by a press conference with Carney and his colleagues 30 minutes later which is never a dull event and certainly won’t be if the central bank once again bottles it.

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