The Pound Could be in for a BoE-sized Surprise this Week 

Image © Pound Sterling Live, Bank of England

- GBP 1st place in G10 ahead of anticipated BoE boost this week.

- UK economic performance, BoE guidance, demand 2019 rate hike.

- BoE to warn complacent market it's still in hiking mode, boosting GBP.

The Pound-to-Dollar rate is already sat on a healthy gain for the 2019 year but it could be in for a further boost this week if economists are right in warning suggesting the Bank of England (BoE) could feel compelled this week to begin preparing the market for a rate hike in the middle of summer. 

Economists and analysts are warning in increasing numbers that the Bank of England will not be able to ignore the solid economic data that has emerged from the UK economy during recent months, when the Monetary Policy Committee announces its latest decision at 12:00 London time Thursday.

The Bank of England has said repeatedly that, assuming a so-called no deal Brexit is avoided, it will need to raise UK interest rates steadily over the coming years in order to ward off inflation pressures that are building in the economy. Most economists assume this means around one rate hike per year. 

"The MPC likely will vote unanimously to keep Bank Rate at 0.75% on Thursday. Nonetheless, we see no fewer than ten reasons why it likely will seek to recalibrate the path for interest rates anticipated by markets, which has fallen sharply and incorporates only a 25% chance of a rate hike this year," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

Above: British Pound performance. Source: Pound Sterling Live.

Tombs, who has been ranked by Bloomberg and Reuters as the UK's top economic forecaster, says the BoE will not set a date for its next rate hike this week but that it will want to wake the market from a complacent slumber. 

Most of the developed world's central banks including the Federal Reserve (Fed), Bank of Canada (BoC), European Central Bank (ECB) and others have moved to the sidelines of the monetary policy field in recent weeks by delaying previously planned rate rises and in some cases warning that the next move in their cash rates could actually be downward. 

The 2019 about-turn on earlier monetary policy guidance came in response to an economic slowdown in China and Europe, which many see as having been brought about by the U.S.-China trade war, although financial markets have lumped the Bank of England in with the rest to the extent that pricing in the overnight index swap market no longer reflects any meaningful scope for rate hikes in the UK this year. 

"The BoE has been one of the few major central banks not to change its policy guidance this year. Its unwavering commitment to an “ongoing” tightening of monetary policy, provided a Brexit shock doesn't crystallise, implies that it cannot let a calendar year pass without raising Bank Rate," Tombs writes, in a briefing to clients. 

Above: Pound-to-Dollar rate shown at daily intervals.

The Pound-to-Dollar rate was quoted 0.14% higher at 1.2921 Monday and is up 1.42% for the 2019 year, although at one point in February it had gained more than 5% over the greenback since the New Year. 

Pricing in the overnight-index-swap market implied on Monday, a bank rate of just 0.71% for May 02, 2019 and a rate of just 0.78% for December 19, 2019. The former is below the current cash rate and the latter is only 0.03% above the existing rate. 

That pricing suggests that investors currently see more chance of an interest rate cut before May than they do a hike, while both numbers suggest investors are pessimistic on the odds of a rate hike coming at all this year. 

Should the Bank of England beg to differ with that outlook on Thursday then it could trigger a sudden and potentially violent response from Pound Sterling, with the British currency likely to advance on all of its G10 rivals at that stage. 

Above: Pound-to-Dollar rate shown at weekly intervals.

The BoE raised its cash rate to a post-financial-crisis high of 0.75% in August 2018 but it's since been thrown off course from further rate hikes by the Brexit farce still playing out in the UK parliament, with a House of Commons full of anti-Brexit MPs at loggerheads with each other over how best to exit from the EU.

However, and as much as the UK's departure from the political union may have been delayed by infighting among MPs, the economy has continued to defy expectations even in the face of what has at times been described as a 'constitutional crisis' and the ever present threat of a no deal Brexit. 

Economic output rose by a total of 0.7% in the first two months of the year, which is even faster than the 0.6% pace of growth seen through the whole of the third quarter of  2018 and puts the economy on course for its best quarter since the period spanning April to July 2015.

Meanwhile, the UK unemployment rate has fallen to a new post-1973 low of 3.9% and wages are growing at their fastest pace in nominal terms since before the financial crisis. Pay adjusted for inflation is also growing at a healthy clip and nurturing economist fears of even higher inflation further down the line. 

"Since the Brexit vote in June 2016, the BoE has raised rates twice. But labour markets continue to tighten and wage growth is accelerating. Inflation expectations have risen on a sustained basis," says Kallum Pickering, an economist at Berenberg. "A strong signal would be needed to ready markets if indeed a hike is coming soon."

Interest rate decisions are normally only made in relation to the inflation outlook but impact currencies because of the influence they have over capital flows and the opportunity they provide short-term speculators. 

Pantheon's Tombs and Berenberg's Pickering are not alone in looking for a 'hawkish' message to emerge from the Bank of England on Thursday as both UBS and Deutsche Bank also wrote to clients Monday warning of an upbeat message from the BoE. Others could join this emerging chorus over the course of the week. 

"While inflation has remained weak at the start the year, we expect this to change as wage growth continues to feed into prices over the coming months with headline CPI projected to push past target early next year. Overall our call for an August rate hike stands as we no longer think the Bank can remain impervious to the stronger data and weaker supply outlook," says Oliver Harvey, a macro strategist at Deutsche Bank. 

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