Will the BoE Appear Hawkish Enough to Push the Pound Higher?

With the Bank of England (BoE) dropping calls that the UK is facing its longest recession since records began, investors are hoping, or even demanding, of more aggressive action. With that in mind, Thursday’s monetary policy decision at 11:00 GMT may attract special attention as traders may be eager to see whether Bailey and co will rise to the occasion. However, they will be already locked in front of their screens as just the day before, the UK CPIs for May are coming out.

Bailey and co under pressure to tame inflation

When they last met, BoE policymakers delivered their 12^th successive rate hike, abandoning their recession calls and signaling that they will not hesitate to raise interest rates should inflation pressures persist.

Around two weeks after the decision, the inflation numbers for April revealed that the headline CPI slowed by less than expected, to 8.7% year-on-year from 10.1%, but what was much more worrisome was the unexpected acceleration in underlying inflation to 6.8% y/y from 6.2%. This suggested that price pressures are becoming more embedded in the broader economy, and that the decline in the headline rate was just the result of a slowdown in the prices of volatile items like energy.

So, after being criticized by politicians for his response to persistently high inflation, Governor Bailey is now under pressure to rise to the occasion and deliver not only another rate hike but also a message that is hawkish enough to satisfy everyone that’s been questioning the BoE’s ability to produce results.

Investors expect several more hikes

Market participants are also demanding more by the BoE. They are now pricing in around 140bps worth of additional rate increases, and that’s even after the PMIs for May disappointed. Perhaps, investors remained content with the fact that the composite index continued pointing to expansion, which enhances the view that the UK economy may have avoided a recession.

What may have also convinced them to maintain their hike bets is the employment report for April, which revealed a stronger-than-expected acceleration in wage growth and a small decline in the unemployment rate. Accelerating wages could translate into accelerating consumer demand and thereby higher inflation.

Therefore, pound traders will stay locked in front of their screens from the day before the meeting decision, when the UK CPI data for May are released. The headline rate is expected to have declined to 8.5% y/y from 8.7% and the core to have held steady at 6.8%, a combination that’s very unlikely to encourage market participants to scale back their hike bets.

Spotlight to fall on the accompanying statement

Putting all the aforesaid information into the same equation, a 25bps hike on its own on Thursday is unlikely to help the pound extend its latest gains. Actually, it could even trigger a small setback as traders assign a 25% probability for a bigger 50bps hike. With neither updated economic projections nor a news conference, the spotlight is likely to quickly turn to the accompanying statement.

If officials turn more hawkish and say that they will continue raising rates until inflation is brought to heel, instead of noting that they will not hesitate to do so if price pressures persist, investors may feel comfortable adding to their long pound positions. The currency could gain the most against the wounded yen, which accelerated its tumble on Friday after the Bank of Japan kept its ultra-loose monetary policy untouched, maintaining its pledge to continue “patiently” with monetary policy easing.

Pound/yen could extend steep rally

Pound/yen has been in a rally mode since last Tuesday and on Friday, it emerged above the 180.50 barrier, marked by the inside swing lows of September 7 and October 2, 2015. This, combined with the fact that the pair is trading above the steep uptrend line drawn from the low of March 24, paints an overly positive picture and a hawkish BoE may encourage traders to begin a journey towards the 188.00 zone, which acted as a ceiling back between August and November 2015.

Now, in the case of the Bank disappointing those expecting a more aggressive stance, the pair is likely to fall off the cliff and perhaps break the uptrend line. It could find initial support at around 175.00, but if the bulls are not willing to enter the action around there, the tumble may extend towards the 171.20 territory, which offered support between May 18 and 24.