Pound to Rally against Euro, Dollar on a Surprise Dec. Rate Hike

Image © Pound Sterling Live

If the Bank of England goes ahead and raises interest rates on December 16 Pound Sterling would likely rally, as such a move would take the market by surprise.

Money market pricing suggests there is now a mere 33% chance of a rate hike in December, down sharply on odds that were closer to 100% just last week.

Consensus expectations are therefore effectively set for no move by policy makers at Threadneedle Street, which means a hike will be the kind of surprise that would prompt a rally in Sterling.

Such an outcome would be the polar opposite to the Pound's decline that came after the Bank surprised against expectations in November by not raising rates.

Above: Daily charts for GBP/USD (top) and GBP/EUR (bottom).

• Reference rates at publication:
  Pound to Euro: 1.1760 \ Pound to Dollar: 1.3313
• High street bank rates (indicative): 1.1530 \ 1.3040
• Payment specialist rates (indicative: 1.1700 \ 1.3246
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The decline in the Pound against the Euro and Dollar over the past week is linked to fading expectations for a December rate hike amidst growing fears the Omicron variant will knock UK growth lower.

"The money market have slashed the probability of a 15bps BoE December policy rate hike because of the new coronavirus fears," says strategist Elias Haddad at Commonwealth Bank of Australia.

Therefore external drivers are ultimately funnelled back into Bank of England interest rate policy expectations which in turn impacts on the Pound.

The odds of a 25 basis point hike in February are however still elevated at 90%.

Looking ahead the Pound will find itself better supported once the December rate hike has been fully 'priced out', provided the odds of a February hike stay intact.

Should the Omicron variant turn out to be worse than expected some February hikes could be shaken out of the tree, pressuring Sterling lower still.

Leaning against a December rate hike was Bank of England Monetary Policy Committee member Catherine Mann who on Tuesday said it's too early to talk about the timing of a rate rise, much less by how much.

Mann said Omicron poses a particular question mark over consumer confidence.

That observation is well founded as the latest incoming 'real time' data from the economy suggests consumers are already starting to retreat.

Covid-19 cases, hospitalisations and deaths might be falling in the UK, but a portion of the populace is clearly fretful of a new wave of the virus might strike at some point in the future.

This is reflected in lower mobility, restaurant bookings and internet search activity related to social activities.

"Real-time indicators suggest that the consumer services sector already has been knocked back since the news of the Omicron variant emerged last week," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

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Mann said Omicron could leave us in a situation of more slack in demand for services, but she also notes inflation is elevated and some of this is being driven by strong consumer demand which suggests she would lend her vote to a rate rise at some point in coming months.

The Bank's Chief Economist Huw Pill said in Bristol last week he was still unsure as to whether he would vote for a rate hike in December.

Jonathan Haskell and Silvana Tenreyro both spoke last week and gave the impression they were warming up to the idea of higher rates, but December looked too soon in their view.

"For central banks, the spike in uncertainty and the downside risks to near-term economic performance are a clear reason to hold back," says Holger Schmieding, Chief economist at Berenberg Bank. "At the BoE, swing voters may possibly see Omicron as a reason to potentially delay rate lift-off from December to February 2022."

Francesco Pesole, FX Strategist at ING says a worsening of the virus situation globally and specifically in the UK may put downward pressure on GBP/EUR due to the pound’s higher sensitivity to risk sentiment.

It may also mean markets could increasingly price out a December rate hike at the Bank of England, he says.

"We expect market participants to remain more cautious about risk taking until there is greater clarity over the potential impact from the new Omicron variant," says Lee Hardman, Currency Analyst at MUFG.