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Sterling pops on Bank of England hawkish surprise

pound coin

Having spent most of 2021 afraid of its own shadow, the Bank of England appears to have suddenly discovered its appetite for rate hikes after it raised interest rates by 25bps to 0.5%, as expected, however the surprise wasn’t in the decision it was in the composition of the vote.

4 MPC members voted for a 50bps hike to 0.75% in a move that was much more hawkish than expected. The bank also ended its corporate bond buying program which appears to show that they are now much more concerned about current, as well as future levels of inflation.

This is reflected in the central bank saying it expected headline inflation to peak at 7.25%, up from its previous estimate of 6%, largely because of the rise in the energy price cap.

The bank also upgraded its inflation forecasts for 2022, up from 4.6% to 5.7%, while downgrading its GDP forecast from 9.5% to 7.8%. For 2023, GDP was revised down to 1.8% from 2.1%, while inflation was revised up to 5.2% from 3.3%. CPI is then expected to return towards target in 2024. 

The four members who voted for 50bps were Dave Ramsden, Jonathan Haskel, Catherine Mann, and Michael Saunders, which suggests that if we see UK CPI increase again when the January numbers are published in just under a fortnight, then another increase in March is probably a done deal.

Coming on top of today’s announcement of the raising of the energy price cap and the new tax rises arriving in April, this isn’t good news for the UK consumer, as we head into the spring and summer months.

While the Chancellor has announced some mitigation measures in this morning’s announcement of fiscal help in the form of grants and rebates, some of these won’t fully kick in until October, which means that we’ll need to be hoping for a warm spring and summer.

The pound not unexpectedly has shot higher on the back of this morning’s announcement, pushing it to its highest levels since February 2020, against the euro, while 2-year gilt yields have risen to their highest level in over a decade.

10-year gilt yields have also risen hitting their highest levels in over 3 years.

The response in the value of the pound has been telling initially pushing higher against the US dollar, however it has since fallen back. The uptrend remains intact from the December lows, with a potential move towards 1.3700 and the 200-day MA expected to be a key resistance.

Source: CMC Markets

The future direction is likely to be dictated by its performance against the euro where we could see further sterling strength if the ECB persists in its narrative that inflation is transitory and ignores the risks of more persistent inflationary pressure in the euro area.

Source: CMC Markets

The risk in EUR/GBP is a short squeeze back to 0.8400, but the narrative remains for a move lower towards however the 2020 lows between 0.8270/80 are the next key support level, which if it holds could delay further gains for the pound.

A move below 0.8250 could be the catalyst for further sterling strength, but that will depend a great dela on the future policy moves from the ECB, especially if the Bank of England continues to raise rates to where markets are currently pricing, which is 1% by the summer.

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