"Pound Surging Higher" against Euro, Dollar on Bank of England Rate Hike

• Pound to Euro at 1.1828
• Pound to Dollar at 1.3361
• "The market had largely priced out a hike. This a surprise" - Mizuho.

Above: Andrew Bailey - Governor, Bank of England. Image courtesy of the Bank of England, reproduced under CC licensing conditions.

The Bank of England raised their main interest rates by 15 basis points to 0.25% and the British Pound rallied in response.

Pound Sterling was half percent higher against the Euro and three-quarters of a percent higher against the U.S. Dollar in the moments following the announcement.

The Monetary Policy Committee (MPC) voted by a majority of 8-1 to increase Bank Rate which in itself can be considered a bullish signal for Sterling, as noted in our preview article.

Gains came against all its major peers in a sign that a good segment of the market was not prepared for the move, expecting policy makers to delay in light of rising Coronavirus cases in the UK.

But the Bank could no longer ignore the spectre of surging inflation that is now well past their 2.0% target and risks settling above target on a longer term basis.

"The pound is surging higher. The market had largely priced out a hike. This a surprise given the recent Omicron onslaught. Investors in large part had come around to the idea the bank would delay hikes into 2022. The pound should remain firm on this move," says Neil Jones, currency dealer at Mizuho Bank.

Above: GBP/EUR rallied in the wake of the decision.

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In a statement the Bank said "the MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework."

Therefore, although they acknowledged the spread of Omicron and the associated risks, they had to inevitably react to inflation.

"Obviously, the BoE is focusing on inflation even when it comes to the impact of the omicron variant. This is an indication that the central bank is considerably concerned about price stability," says Bernd Weidensteiner, Senior Economist at Commerzbank.

Specifically, Bank economists note a sharp rise in core elements of the inflation basket; an explicit reference to that part of inflation which the Bank has scope to consider.

"There has been significant upside news in core goods and, to a lesser extent, services price inflation. Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022," said the statement.

And importantly, further rate hikes look to be in the pipeline:

"It would be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target," read the statement.

Above: "Next rate hike (to 0.50%) coming in February, according to panicking markets" - Samuel Tombs, UK Economist at Pantheon Macroeconomics. Image courtesy of Pantheon Macroeconomics.

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The development makes the Bank of England a first mover on interest rates amongst its major peers which should bestow upon the Pound a rates advantage, particularly against currencies belonging to central banks that are likely to be slow in hiking.

“Despite this morning’s PMI data and the extraordinary rise in Covid cases the Bank of England’s clearly feels vindicated to raise interest rates just before Christmas. Given high, and rising, inflation, in part a result of the Bank’s communication missteps creating a de-facto weaker sterling policy, it clearly felt it could no longer stay on the accelerator pedal despite the risks that are now out there in the economy," says Hinesh Patel, portfolio manager at Quilter Investors.

Acknowledging UK economic growth was to slow in the light of the Omicron variant's spread, Bank economists revised down their expectations for fourth quarter gDP growth to 0.6%, from 1% at the time of the November Report.

Bank economists now expected GDP in Q4 to be around 1½% below its 2019 Q4 level.

But crucially Bank economists now expect the UK's unemployment rate to fall to around 4% in the fourth quarter as a strong trend in the labour market continues, this compares with the 4.50% projection in the November Report.

As such, the MPC acknowledged that upside risks to wage pressures were growing.

Andrew Sentance, Senior Adviser at Cambridge Econometrics, said the decision was "one small step towards more sensible monetary policy. MPC raises interest rate to 0.25 percent with 8-1 vote. A small step in the right direction, hopefully to be followed by others in 2022."

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But Daniel Vernazza, Chief International Economist at UniCredit, says the Bank of England will likely bypass a February rate hike, opting to asses any damage caused by Omicron.

"In our view, the MPC should probably have waited a little bit longer before raising rates. The UK economy was already slowing materially before the Omicron variant was identified," says Vernazza in a post-decision note to clients.

He says the sharp rise in COVID-19 cases along with a significant squeeze in real disposable income (from high inflation and reduced fiscal support), low consumer confidence and slightly tighter monetary policy will likely all make for a difficult few months ahead.

"We think these headwinds will likely force the MPC to pause raising rates for some time now, although it will probably be able to do one more hike before the end of next year," says Vernazza.

If correct, the market will have to wipe out the hefty expectations for another rate hike in February.

Given the recent hawkish turns at the ECB and Federal Reserve this could leave the Pound exposed to downside.

For Sterling to extend higher February rate hike expectations must hold, at the very least.