On Thursday, the Bank of England meets and it is faced with a tough decision. In an ideal world, it wants to be able to signal to markets that inflation is under control and that perhaps the BoE does not need to hike interest rates anymore. The problem is that inflation in the UK is still in double digits.
The UK’s inflation problem
Headline inflation in the US is at 5%, at 7% in the Euro area, and at 4.3% in Canada. In fact, in the G20 the only countries which have higher inflation than the UK are Turkey and Argentina.
Headline inflation in the UK is at 10.1% and there are strikes for extra pay throughout various UK sectors including teachers, doctors, nurses, and railway workers.
Of even more concern to the BoE will be the fact that core inflation remains ‘sticky’ at 6.2%. The core reading excludes energy and food prices but is well above the BoE’s 2% target. There is clearly more work for the BoE to do.
Short-term interest rate markets are expecting an 84% chance of a 25 bps hike. They are also expecting a terminal rate of 4.85%, so that is another hike expected in the summer. Look at the implied interest rate curve for the Bank of England from Financial Source’s interest rate tool below.
A good opportunity for the GBP would come if the BoE hold back from hiking rates. If it decides to pause and wait to see how the prior hikes impact the UK economy then watch for sudden moves higher in the EURGBP. However, if the BoE hikes, and then signals a series of more rate hikes to come then watch for moves lower in the EURGBP on GBP strength. Remember, a hike is expected, and then another hike in the summer, so that is the base case.