Fundamental Analysis

Is BoE Any Closer to Raising Interest Rates?

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What's More Important to the BoE, Inflation or the Economy?

The Bank of England faces a dilemma when it meets on Thursday between getting inflation in check and supporting the flagging post-Brexit economy.

With the central bank significantly overshooting its 2% inflation target - CPI rose to 2.9% in August - the answer may appear simple but with policy makers divided, that is clearly not the case.

The depreciation of sterling has played a major role in the inflation rise over the last year and with the currency having bottomed last October, it is plausible that once the base effects drop out of the annual comparison, inflation will fall closer to target. But can policy makers rely on that?

As we can see from recent voting, there is a growing belief that this cannot be relied upon. The important question therefore becomes, will enough policy makers decide they can't rely on it before the data starts to correct itself?

With only two policy makers - Ian McCafferty and Michael Saunders - having voted at the previous meeting to raise interest rates and a ninth member having since joined the Monetary Policy Committee, it seems unlikely that the hike threshold will be passed this week.

That said, the pound did not necessarily rally over the last couple of weeks on the expectation that the BoE will raise interest rates on Thursday, rather on the expectation that it is getting closer. The inflation reading on Tuesday further fuelled the expectation while Wednesday's wage data tempered it slightly.

What Can We Expect on Thursday?

While a rate hike at the meeting is very unlikely, central banks have surprised us in the past and given how other central banks (ECB, Bank of Canada) are exploring tighter monetary policy, it remains a possibility, albeit a small one I would say.

What traders are most interested in is what impact the August inflation number had on those policy makers that have been borderline hike voters but remained with the majority until now. There is also one new policy maker on the committee this month - Sir David Ramsden - and another that only joined in July - Silvana Tenreyro - who's views we still know little about.

It may not take as much as we thought to sway the vote in favour of a rate hike, at which point I would expect to see a sharp move higher in the pound, as that is not priced in.

What's more likely is the voting will either be unchanged - with only McCafferty and Saunders voting for a hike - or perhaps one more policy maker will join them. This may even be enough to provide some upside for the pound in the near term.

The minutes will be of interest to traders but the reality, particularly if they allude to inflation becoming a concern to policy makers or some policy makers being tempted to vote for a hike. That would suggest any further uptick in inflation going forward could result in higher rates.

Author: MarketPulseWebsite: http://www.marketpulse.com/
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