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On Thursday the Bank of England meets and a 50bps rate hike is fully priced in. A 75bps rate hike is seen by Short Term Interest Rate markets as having an 80% chance. The key aspect of this meeting is going to be what the BoE signal about the growth outlook and what happens to quantitative tightening. So, here is a broad outline of how to trade the BoE.
 

Inflation peak?

In the last BoE meeting inflation was expected to peak by 13.5% in October. However, that was before Liz Truss’s £100 billion emergency energy package was announced. With energy price hikes being absorbed by the UK packages that should allow inflation to peak underneath the 13.5% target.
 

Behind the curve?

 Due to the lag between hiking interest rates and cooling demand the BoE, like other central banks, is having to rapidly hike rates as it finds itself behind the curve. In other words, it is quickly trying to hike rates to try and cool inflation as quickly as possible. Now the extent to which the BoE feels this will impact whether the BoE hike by 50 bps or 75bps. A larger 75bps hike will signal the BoE is getting tough on inflation.

The BoE is planning on starting QT, but a question remains as to whether this is a good time to start QT just as Liz Truss has announced a huge emergency energy program. The plan is for the BoE to sell about £40 billion of gilts in the first 12 months, but whether they do so or not is in doubt.

QT plan
 

The terminal rate

The implied interest rate curve sees the BoE hiking interest rates to 4.5% in the summer of next year. Interest rates are currently at 1.75%, so there is plenty more hikes expected. One key question going forward is going to be when will the BoE signal a pause. Will they confirm a 4.50% terminal rate or push back against it?
 

The trade-out of the BoE

There are a lot of moving parts here but here is a rough outline to work with. 

• Hike by 50bps, confirm higher rates than 4.50%, start QT= GBP bullish 
• Hike by 75bps, confirm higher rates than 4.50%, start QT = GBP bullish 
• Hike 50bps, push back 4.50% terminal rate, postpone QT = GBP bearish

A word of caution. This is a tricky decision as there is a chance here that the BoE spook markets by being too aggressive as growth slows. If the market sees this as the case then the GBP could still sell off even on a 75 bps rate hike. If the market sees the BoE as bringing the UK into a stagflationary environment watch for GBP selling. So, in particular with this meeting, the GBP outlook on the above scenarios is the likely reaction, but the markets can always surprise – so manage risk carefully and be prepared.

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