Pound Sterling at Risk of "Sell the Fact" Reaction to Bank of England

The British Pound could fall in response to an eagerly-anticipated rate hike from the Bank of England Thursday, says one strategist, as the first increase in bank rate for a decade is now the minimum that traders expect.

Sterling is seen edging lower against a host of major currencies ahead of the mid-day Bank of England policy decision. The declines reflect nerves amongst markets that the Bank might not deliver a 'hawkish-enough' message on where rates are going in the future.

There is a 90% chance the Bank of England raises interest rates and with such certainty, there is little room for notable upside moves in Sterling on the eventual announcement, owing to the decision being so well signposted.

Sterling has risen notably since the nine-man Monetary Policy Committee at the Bank of England warned in September that an interest rate rise was imminent.

The currency has subsequently pared more than half of its 2017 losses against the Euro: The Pound-to-Euro exchange rate is now down just -3.5% in 2017, from around -7.5%, while the British currency has gained further on the US Dollar taking the Pound-to-Dollar rate's 2017 return to +7.5%.

“Recent gains leave GBP vulnerable to a pullback unless the MPC sends further hawkish signals through the vote or guidance on future rate path,” says Richard Kelly, head of global strategy at TD Securities. “Our base case suggests a 'sell-the-fact' reaction is likely for Sterling.”

The move lower in the Pound ahead of the event could actually be a sign the "sell the fact" trade is already underway as traders look to preempt their peers. 

GBPUSD broken swing low this morning. Good chance we are seeing a 'buy the rumour, sell the fact' for GBP. Depends on #BoE forward guidance pic.twitter.com/TF2igH798u

— Joshua Mahony (@JMahony_IG) November 2, 2017

Others share the view Sterling is at risk of decline.

“GBP was last seen at 1.3270 levels”, Saktiandi Supaat, a currency analyst at Maybank in Singapore, noting a downward Pound-to-Dollar support level at 1.3180. “We caution for 'buy on rumor, sell on fact ' play.”

Bond market and interest rate derivatives prices suggest there is nearly a 90% probability the Bank of England will raise the base rate by 25 basis points to 0.50% Thursday; those same markets suggest a further two hikes could come inside the 2018 year.

What matters for the Pound is whether or not the Bank confirms those 2018 rises are likely.

“While we do expect BoE to tighten this round, we do not see this as the start of rate hike cycle as BoE is expected to strike a balance between arresting inflation and ensure it does not derail growth momentum,” says Supaat.

With markets already set in their expectation the BoE hikes, assuming it actually does, what matters most for the Pound Thursday is the bank’s guidance around future interest rate moves. Traders will also look closely at the BoE’s latest quarterly inflation forecasts.  

“As if any further confirmation was needed, the stronger-than-expected UK GDP data last week virtually sealed the deal for a November rate hike and over the near term, we believe the UK rate cycle will be the bigger driver for GBP than the Brexit negotiations,” says Robert Wood, chief UK economist at Bank of America Merrill Lynch.

Markets already expect more rate hikes to come during the year ahead but economists and strategists are divided on the merits of further tightening.

Some suggest the BoE’s Thursday move should be a “one and done” affair while others have called for a steady and gradual hiking cycle that could take the bank rate to 1% by the end of next year.

“While we have some sympathy for the "one and done" we think the BoE will want to retain some optionality for rate hikes next year, but not to the extent that is priced into the curve at present,” Wood adds.

Any suggestion by the BoE that Thursday’s hike is a one-and-done affair would surely be bad for Sterling. A dovish move, such as making any further hikes heavily contingent on the economy regaining some more of its lost momentum, might also go down badly.

“In our view, therefore, and given the build-up in GBP longs in recent weeks, we think the risks to GBP are to the downside headed into the Quarterly Inflation Review,” says Wood.

Put more succinctly, once recent gains for the Pound and current expectations for interest rates are taken into account, it would appear that only a “hawkish outcome” from Thursday’s BoE statement would be sufficient enough to push Sterling higher.

For the Bank of England to come across as sufficiently “hawkish” there would have to be a solid majority of the MPC in favour of Thursday’s hike, with the vote split along the lines of 8-1-0, and a fairly direct hint that another move is just around the corner.

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