BoE not yet on the top of ‘Table Mountain’
One of the primary reasons for the recent decline in the performance of the British Pound (GBP) can be attributed to a significant reassessment by the financial markets regarding the potential for additional interest rate hikes by the Bank of England (BoE). In fact, both the GBP and the market's predictions for the ultimate BoE interest rate reached their highest levels in late July and have been steadily declining since then. The most recent inflation figures from the United Kingdom have come in below expectations, solidifying the belief among market participants that the BoE's tightening cycle is nearing its peak. Additionally, market sentiment suggests that the BoE's tightening cycle will likely peak at just under 5.50% in the coming months.
However, it is my view that the Monetary Policy Committee (MPC) would be premature in declaring victory over inflation at this juncture. I assume I was wrong on anticipate a 25-basis point interest rate hike yesterday for the BOE, and wrong as well on speculate that they would accompany by forward guidance that underscores the importance of remaining vigilant in addressing inflation. Indeed, despite recent signs of weakening inflation and economic activity in the UK, the BoE will place significant emphasis on the still-tight labour market and persistently high wage growth, which could continue to drive inflation in the months ahead. Furthermore, with real wage growth now on the rise, the risk of stagflation in the UK is diminishing, which justifies a slightly more optimistic economic outlook. In sum, I believe that the BoE has not yet reached the zenith of its interest rate adjustments, a sentiment in line with Chief Economist Huw Pill's metaphorical reference to Table Mountain when describing the bank's rate outlook in August.
The British Pound (GBP) could potentially rebound today in response to an interest rate pause for profit taking but no more than 1.23 and forward guidance that indicates the BoE's willingness to take further action if necessary. This conclusion holds true even if the voting split within the MPC suggests increasing disagreement among policymakers regarding the need for additional tightening. Additionally, today's focus will be on the BoE's outlook for Quantitative Tightening (QT). Preceding this, market expectations are that the MPC will once again reduce its balance sheet by £100 billion over the next 12 months, primarily achieved through reductions in its holdings of government bonds (gilts).
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