The Bank of England has to avoid two ditches. On one side of the road is the ditch of high inflation. With UK inflation over 10% and the core at 6.2% the BoE is trying to fight off deep rooted inflationary pressures, so it has to keep hiking rates. On the other hand the BoE knows that too aggressive an approach to inflation will result in the UK falling into the other ditch by sharply slowing growth. However, the BoE upgraded growth forecasts at the last BoE meeting with the largest GDP upgrade on record, but is that reasonable?
So, the BoE is trying to steer a compromised course for rates without falling into either ditch.
On May 11 the BoE hiked by 25 bps with a 7-2 vote split. This was entirely expected as 2 members Dhingra and Tenreyo dissented from vote hikes as they were expected to. The future path for the BoE will depend on the incoming inflation data.
April’s headline inflation to drop sharply
The BoE have signaled that CPI inflation is expected to fall sharply from April partly because large rises in the price level one year ago drop out of the annual comparison. This is due to what’s called ‘base effects’. Base effects refer to the impact that changes in the base period (or reference period) used for comparison can have on calculations of a given variable. Furthermore, the extension in the Spring Budget of the Energy Price Guarantee and falls in wholesale energy prices should also lower the input of household energy bills into CPI inflation.
inflation data is now key for the GBP’s next moves
The next UK inflation data print will be really crucial to watch out for as it will set expectations for the BoE’s next rate hike. If inflation keeps coming in high than interest rate expectations will continue to gain which should increase GBP buying. On the other hand, if inflation sees a sharp drop off, then interest rate expectations will sharply fall and that should embolden GBP sellers.
The impact of higher interest rates still to be felt
According to Bloomberg the interest rate rises are still to be fully felt in the UK mortgage market. Take a look at the chart below:
What this means is that the full impact of BoE interest rate hikes are still to be felt by many UK homeowners. The verdict? The cost of living crisis is set to get worse for some people as they renew their mortgages at much higher rates.
So, going forward many analysts are nervous on the GBP’s upside. Over the last 7 months the GBP has gained for 6 of them and that run could be stretched. Certainly moving forward the GBP will be vulnerable to bad news.