Reuters: Great confusion on Bank of England rates

07 December 2022 225
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Source: Reuters

Author: Mike Dolan

Article: Original article

Publication date: Wednesday, December 7, 2022

The vaguest part of the vague forecasts of all the major central banks for next year is the trajectory of the Bank of England rates, as the market outlook seems to diverge from the Bank of England guidance.

Right after its November announcement of a rate hike, the bank itself has publicly opposed excessive rate hikes in the UK next year. 

And yet market prices have barely wavered since then - despite tight fiscal constraints, oil prices falling nearly 20%, and the consensus of official forecasters that the British economy is already in recession.

When the Bank showed its largest rate hike in more than 30 years on November 3, by 0.75% to 3%, the markets were expecting a peak rate of about 4.75% next summer. And now expectations are slightly lower, at 4.60%.

Economists' average projections for next year's peak rate are 4.25%, it’s about 35 bps lower than the market estimation. Many major banks still see a terminal rate of 3.75%, almost a full point below market price.

The question is why has the Bank of England's apparent refusal to raise rates excessively had no impact. Partially the reason is that the Bank's own policy council may be split.

Dovish Bank of England board members Silvana Tenreyro and Swati Dhingra voted for less than a 75 bps rate hike last month and still believe that the recession is what changes conditions. According to Tenreyro’s estimates, the Bank of England should keep the rate at 3.0% next year, and then lower it in 2024. Otherwise, there’s a risk to push the inflation below the target level in the medium term.

It’s highly likely that Governor of the Bank of England Andrew Bailey and chief economist Huw Pill will prevail this week and raise the rate by 0.5%. Still, many analysts think that hawks Catherine Mann, Dave Ramsden and Jonathan Haskel might call for a 75-basis-point hike, while the monetary policy committee might split.

Clear uncertainty that was caused by the failed mini-budget and the bond market turmoil in September has resulted in a greater risk premium in British markets.

Any reversion of the interest rate to the consensus or below might lead to another period of volatility for the pound. Implied volatility in the pound sterling is half of the September peak, but it is still above the historical average by more than 10%.

Moreover, the depth of approaching recession in Britain is the driver of many dovish assumptions regarding the rates. But for now it’s still unclear, as the gloom might be exaggerated, while economic indices of Great Britain remain at their most positive levels since April.

As it’s suggested by the National Institute of Economic and Social Research, the Bank of England just wouldn’t be able to return inflation to the 2% target without increasing rates to 4.75%.

Deutsche Bank shares a similarly hawkish attitude: it supposes the final rate to be at the level of 4.5% due to excessively negative projections of the Bank concerning GDP growth and inflation.

But it also sees some risks, as the Bank of England seems to be determined to go against the markets. As it was stated by Deutsche representative, there’s a premium in place, especially considering a fact that inflation is still ahead of market expectations and the Bank itself. But, as it was noted, the company underlined the risks to its terminal rate forecast, given the constant dovish messaging from the Bank’s representatives. According to the representative, there are still some things to observe.

Forecast: the GBPUSD is likely to decline

This content is for informational purposes only and is not intended to be investing advice.

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