It has been a long time coming but the Bank of England is widely expected to raise UK interest rates on Thursday. For traders, the big question will be whether this means the start of long term period of tightening of monetary policy or just a one off.
November is considered to be an ideal window of opportunity for the Bank of England: it can raise rates and give the Monetary Policy Committee the ammunition it needs to cut them again should we hit an economic downturn next year, which, given the uncertainty around Brexit, is eminently possible.
The overnight index swap markets (OIS) are shouting about a 90% chance that the Bank of England will raise rates by 25 basis points (0.25%). But there is always a chance the MPC will shy away from it, given the Brexit clouds hovering over the UK economy.
“Sterling ought to be lifted if interest rates rise, but the currency is also sensitive to the nature of the vote split and any ‘forward guidance’ from the Bank on possible future hikes,” says Neil Wilson, Senior Market Analyst at ETX Capital. “At present there is no consensus that a 25 basis point hike this week would be the start of a gradual tightening cycle.”
At present the OIS market is pointing at a 75% chance of at least one more interest hike in 2018, with a much reduced chance of two hikes. This week’s vote and the communication surrounding it will obviously be important. In September the Bank of England said that monetary policy could be tightened by “a somewhat greater extent over the forecast period than current market expectations.” The Bank also observed in its August minutes that remaining spare capacity in the economy is being absorbed more quickly than expected.
There is still a chance, albeit a small one, that the Bank of England will shy away from an interest rate hike. Wage growth is faltering and there is that small issued of an unresolved Brexit deal.
“There is considerable pressure coming from some corners of the business community to avoid raising rates,” says Wilson at ETX Capital. “The MPC members will certainly be listening and they will no doubt be aware of the history of central banks tightening too soon.”
Bank of England governor Mark Carney also has form when it comes to bluffing the market, saying that rates will rise and then failing to deliver.
The Armchair Trader says:
It very much looks like a rate rise is on the cards, but bear in mind that the UK has been gorging on a zero rate environment with a side order of quantitative easing for 10 years. An entire generation has grown up, relying on cheap credit and low mortgage rates. Any rate rise is likely to have an immediate and dramatic effect on spending, which in turn will have a knock on effect on the economy. Inflation, which is still a key worry for the Bank of England, is being driven by the weakness of sterling. The UK is more reliant on foreign imports than it was in 2008 when we started down this road. We think the Bank will hike, but it will be hard winter when it does.