GBP/EUR Rate Can go to 1.21, but Only if the Bank of England Hikes 50bp Next Week

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The coming week promises further losses for the British Pound unless the Bank of England announces a bigger than expected interest rate rise on Thursday.

The Bank will be the main event for Sterling in the early part of May as another interest rate hike is expected to be announced as policy makers respond to rising inflation levels.

The size of the hike, the vote composition of the Monetary Policy Committee and the guidance on the outlook will decide where the Pound ends next week against the Euro, Dollar and other major currencies.

Ahead of the May policy update the Pound is seen to be under notable pressure against the Dollar, but it has also lost value to the majority of the G10 currencies over the past week.

"Sterling has had a bad week at the office," says Chris Turner, Global Head of Markets and Regional Head of Research for UK & CEE at ING in London. He says the underperformance is the result of a combination of weak UK consumer data, a "much tougher risk environment" and "the pincer movement of higher U.S. real rates and weaker Chinese growth prospects".

This all could have contributed to investors lowering their rate hike expectations at the Bank of England, meaning expectations are low ahead of next week's main event.

Strategists at ING Bank see four likely scenarios transpiring in the wake of the Bank of England interest rate decision and Monetary Policy Report, due Thursday May 07, but three of these see the Pound moving lower.

Their base case scenario envisages a 25 basis point hike with 8 members of the MPC voting in favour and one voting against.

Inflation forecasts are raised but the Bank warns that growth is likely to slow, prompting them to reiterate that "modest" hikes are likely.

This base case scenario would hardly come as a surprise to the market and ING envisages the Euro-Pound exchange rate rising to 0.8450, giving a 1.1834 Pound to Euro rate.

Another scenario sees a 25 bp hike but a more marginal 6-3 vote in favour. Crucially, their forecasts would imply that inflation falls back to below 2.0% over the medium-term as a result of the recent interest rate hikes and rising inflation.

This is ultimately bearish for Pound Sterling which is seen easing back to 0.85 EUR/GBP (1.1765 GBP/EUR). (Set your FX rate alert here).

Even more 'bearish' for the Pound would be the Bank surprising by not raising interest rates on the back of a drastic revision lower in growth forecasts.

This could prompt EUR/GBP up to 0.86 says ING, giving a GBP/EUR of 1.1628.

But, there is also a chance the Bank hikes by a more assertive 50 basis points to get on top of inflation early.

This would follow MPC member Catherine Mann's school of thought as set out in recent speeches: go hard and early to avoid having to raise rates further in the future.

Crucially, the Bank would not push back against that the market's expectations for six more hikes in 2022.

Here the EUR/GBP falls back to 0.8250 says ING, giving a Pound-Euro conversion of 1.2121.

This outcome is however given lower odds than a standard 25 bp rate hike, however, suggesting a low probability of such a move higher in Sterling.

But Pound Sterling Live reported Thursday that independent research consultancy Capital Economics are of the view the market is currently underestimating the number of rate hikes to come out of the Bank of England.

They have updated clients and said Bank Rate could end up at 3.0% in 2022; if they are correct then Thursday could see a more 'hawkish' outcome from the Bank than ING envisages.

Capital Economics says that although economic growth will likely slow the labour market will remain in good health.

This will maintain upward pressure on wages and give the Bank reason to raise rates further as they seek to quash inflation expectations.

Also keep in mind the market has been resolutely bearish on the Pound of late with declines coming against all major peers (apart from NOK) in the past week.

This suggests the market is expectant of the more 'dovish' scenarios playing out, which in fact raises the bar to such outcomes.

Relief could therefore be in store for Sterling holders looking to sell at better rates.