The Bank of England meets on Thursday at 12 p.m. UK time. Markets are expecting a 25 basis point rate hike as the UK continues to struggle to deal with some of the hottest inflation in the G20. Although headline inflation is tracking lower, it is still running at three times the Bank of England’s 2% target.

The GBP has been seeing weakness recently, as very stretched long positioning has started to unwind. A struggling housing market, falling PMIs, and the impact of higher mortgage rates on disposable income have all tempered some of the summer expectations of a 6% terminal rate from the BoE. In the latest CFTC report, presented here courtesy of a financial source, GBP longs have retreated once again:

Some of the GBP crosses have been losing significant value over the last week or so. Short-term interest rate markets see a terminal rate of just over 5 1/2% and there is a one-and-five chance the Bank of England does not increase rates on Thursday. Markets will be focusing carefully on what the Bank of England’s forward projections are for the path of rates ahead.

What to expect

If the Bank of England signals a peak in its rates then expect pound selling out of the meeting. In particular, GBPJPY selling could be attractive with the Bank of Japan meeting early on Friday morning. Some analysts anticipate the potential for the Bank of Japan to signal an exit of a negative interest rate policy.

If it did do this that should strengthen the yen. So one currency pair to look at carefully is the GBPJPY which could be vulnerable to significant falls if the Bank of England takes a more dovish approach to monetary policy moving forward.

Trade risk

The biggest risk is if the Bank of England keeps open the prospect of further interest rate hikes and the Bank of Japan keeps open its negative interest rate policy. In this case, the GBPJPY may end up moving higher rather than lower. Also, if the Fed takes a hawkish path tonight that can weaken the JPY in the near term too.