Summary: After September’s hawkish hold, a dovish hike in November is expected with the Bank set to raise rates but sound cautious on the outlook for future hikes. November is the ideal window of opportunity to raise rates so that the MPC has ammunition in the event of an economic downturn to ease again.

“With the Bank of England (BoE) widely anticipated to hike interest rates for the first time in a decade on Thursday, the key question facing traders is this: Will a hike be the start of a longer-term tightening cycle or is it a case of one-and-done?

Overnight Index Swap markets indicate a roughly 90% chance that the rate-setting Monetary Policy Committee will agree to raise rates by 25 basis points to 0.5%. Markets can get it wrong and there is a risk of no hike given the Brexit uncertainty and signs of weakness in some quarters of the economy.

One and done?

 

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.

At present there is no consensus that a 25 basis point hike this week would be the start of a gradual tightening cycle. Upside risk to GBP is therefore from a more hawkish outlook from the Bank and a signal that this is not one and done. At present OIS markets indicate a roughly one in three chance of at least two further hikes in 2018, but a roughly 75% chance for one more hike. This vote and the communication have the potential to shift these expectations and sterling with them.

In terms of the voting split, a tighter vote may be sterling negative. An 8-1 split would signal confidence in the economy and therefore the possibility of further hikes in 2018, even if the official communication on this front is more cautious.

Hawks

Ian McCafferty and Michael Saunders are the two most hawkish members, having voted for rate hikes already this year. They both preferred to raise rates by 0.25% in September. Andy Haldane looks almost certain to join them, having lately described a hike as a ‘good news’ event. His suggestion that a hike would equate to ‘interest rates getting back to normal, even if the new normal is different to the old normal’, may also be taken as a sign that there is a core of rate setters who think it’s not going to be a case of one-and-done.

With those 3 in the bag, the key question regards whether we get a hike is whether Mark Carney, Ben Broadbent and Gertjan Vlieghe join the hawks. The indications are that they will, but risks remain.

One-time dove Vlieghe said in September that ‘we are approaching the moment when bank rate may need to rise,” and that this “might be as early as in the coming months’. Whether November is too soon remains an unknown but the outlook for the economy does not seem to have deteriorated in the intervening period. The Q3 GDP improvement will probably be enough for Vlieghe to turn hawk, even though there are concerns around retail sales. Likewise Carney is expected to vote for a hike. Broadbent has been quiet and his view will be important – if he votes for a hike he may swing the vote more decisively in favour of the hawks, which would be more sterling-positive.

Doves

Three members appear to be more dovish. Deputy governor Jon Cunliffe said a November hike remains an ‘open question’, adding that ‘the economy has clearly slowed this year’.

Fellow deputy governor Dave Ramsden is clearly dovish, explaining to MPs this month that while a majority of MPC members saw a case for removing some monetary policy stimulus in coming months, he was ‘not part of that majority’. The other new member, Silvana Tenreyro, also appears in no rush to raise rates.

Therefore there is a chance of 3 members voting against a hike. If three do go against a hike it could be bad for the pound as it may be regarded as a signal that in the absence of broad consensus this is not the start of a tightening cycle. Further hikes would come into question. However if either Cunliffe and/or Tenreyro go for a hike it may be taken as considerably sterling-positive as this scenario would support consensus around further hikes.

Communication questions

With a hike expected, for sterling a lot rests on the language contained in the meeting minutes as well as the inflation report projections for a handle on the path of monetary policy.

In September, the MPC said that ‘monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations’.

  • Have markets now accounted for this and caught up with where the MPC is? If this is left in after a hike, it would be taken as a hawkish signal for further tightening in 2018.

Another key passage that markets saw as hawkish revealed that a majority of policymakers thought ‘some withdrawal of monetary stimulus was likely to be appropriate over the coming months’.

  • In the event of a hike, will the MPC seek to guide the market to expect more hikes and leave this passage in?

    On the economy, the September minutes revealed that policymakers observed ‘remaining spare capacity in the economy is being absorbed a little more rapidly than expected’ than in August.

  • Has this trend continued and will the Bank upgrade its economic forecasts from August as a result?

No hike?

 

There is a risk that the Bank pulls back from hiking altogether. There is a small but significant chance the MPC members get cold feet and decide that tightening now would be too soon. Wage growth is faltering, retail sales are starting to buckle and no deal has yet to be negotiated on Brexit. There is considerable pressure coming from some corners of the business community to avoid raising rates. The MPC members will certainly be listening and they will no doubt be aware of the history of central banks tightening too soon.

Above all the threat of a no deal breakup with the EU looms but this is unlikely to form the base case for the Bank. It would also be mindful that with reasonable solid economic fundamentals and inflation at 3% and likely to fall, November is the ideal window of opportunity to raise rates so it has ammunition in the event of an economic downturn to ease again. And we must stress that whatever the Bank does, it can always blame Brexit if the economy suffers.

And finally, Carney has form in signalling rates would rise and then failing to deliver. If the Bank doesn’t hike, this unreliable boyfriend may come home to find his bags packed and the locks changed. Moreover if it is one-and-done, there is less concern about premature tightening. The Bank can probably afford to raise rates now and then wait and see. After September’s hawkish hold, we are likely to get a dovish hike in November.

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