BOE To Hike, Becomes Most Hawkish Central Bank

One of the last major central banks of this meeting cycle is the Bank of England, which is widely expected to hike while other major central banks hold. However, the situation isn’t as dramatic, because the BOE held during the prior cycle, so it’s expected to “catch up” at its meeting on Thursday.

What is more notable is the market forecast, with futures implying the BOE will be the most aggressive in hiking next year by a wide margin. Over the last month or so, markets have been paring back expected central bank hikes, but have not done so for Britain, and still see four more hikes over the next 12 months. This compares to three from the ECB and just two from the Fed. And the RBA, which the market is now predicting to cut next. The question is whether this aggressive stance means the pound will gain, or will the BOE join other central banks in paring back its outlook, weighing on the pound in the process.

Economic Outlook Trumps Inflation

If the BOE goes through with the expected hike, it would be the first time since mid-2023. Which just goes to show how reticent it has been to raise rates, compared to the ECB hiking twice since the summer. Britain is not immune to global inflationary pressures, with economists suggesting that energy prices have already raised consumer prices and will keep upward pressure well into next year.

However, it’s worth noting the relative pivot in other central banks that raised rates but later indicated there is little sign of “second round” effects. That’s key because it indicates whether energy prices are being passed through to the broader economy, raising consumer prices across the board. If the economy remains sluggish, then consumers don’t have the extra buying power to withstand higher prices. Rather than raising inflation, higher energy costs cause demand destruction in other sectors, making rate hikes less necessary or even undesirable.

Autumn Budget Could Force the BOE

While economists generally agree that the British economy has remained resilient, it isn’t expanding. Wage growth has fallen behind inflation, usually an indicator that consumer prices will turn down as well. However, the new Chancellor John Healey was faced with a difficult decision with his Budget last week. Either he had to let low-wage earners see some deterioration in their incomes due to inflation, or raise wages, which would threaten higher inflation.

This is not a situation the ECB is facing as it pivots away from a more hawkish path, which means the BOE might have to act more aggressively going forward than its Continental counterpart. The key, then, is not in what the BOE decides to do, but whether it signals continued concern about inflation going forward.

What the Market is Looking For

With a hike priced in as a near certainty, the 25 bps rate bump alone is unlikely to affect markets. Traders will be looking at the vote split to see whether there is a strong indication that the BOE will deliver a second hike in December. If not, that could weigh on the pound.

But the onus might be on Governor Andrew Bailey, who has said in the past that the Bank can’t wait for definitive signs of second-round effects. If he sounds less sure about the need to raise rates, then the market might take it as a dovish sign, weighing on sterling. If he maintains his rhetoric, the markets might support the pound going into the next round of rate hikes.