Bank of England set to hold, markets eye forward guidance

Focus on vote split and forward guidance as Bank of England appears set to leave interest rates unchanged at last meeting of 2023 

The Bank of England appears poised to maintain interest rates at a 15-year high on Thursday, with investors focused on whether policymakers will push back against the growing market expectations of multiple rate cuts next year.  

The BoE has kept rates steady at 5.25% since August after 14 back-to-back rises starting in December 2021. Governor Andrew Bailey has stressed the need for borrowing costs to stay high “for an extended period” to quash the threat posed by inflation pressures.  

In a recent preview of the BoE’s decision, Markets.com Chief Market Analyst Neil Wilson wrote that the UK central bank may stick to its hawkish messaging: 

“The Bank of England is probably also done with policy tightening and will leave its Bank Rate at 5.25%, having paused already in November. UK interest rate swaps indicate the BoE will be cutting rates next year, though Governor Andrew Bailey has been cautious about endorsing this view, pointing out that inflation remains too high and dismissing rate cut chatter”. 

As other central banks have suggested that interest rate cuts are coming, including the Federal Reserve’s recent dovish messaging on Wednesday, the BoE’s apparent hard line is being challenged in markets. Investors are pricing in nearly five quarter-point cuts to the UK Bank Rate in 2024, with the first cut to take place as soon as March.  

These positions may be worrisome for the BoE, which remains concerned about inflation, which, though lower than its October 2022 peak, remains more than double the bank’s target at 4.6%.  

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UK economic data: Weak readings make faster inflation fall more likely 

Weaker-than-expected UK economic data raises the possibility of faster inflation decline, potentially altering the BoE's course.  

In October, the UK economy contracted by 0.3%, marking its initial decline since July and raising concerns about the possibility of a recession.  

Despite a more sluggish-than-anticipated wage growth of 7.3% in the three months leading to October, the figure remains in proximity to the previous peak of 7.9% observed during the summer. This continual growth in wages remains a primary source of concern for the Bank of England regarding inflation. 

The BoE also has to take into account Finance Minister Jeremy Hunt's budget update from November 22, which laid the groundwork for tax reductions ahead of the anticipated general election in 2024. 

The central bank's announcement will be sandwiched between those of the U.S. Federal Reserve and the European Central Bank (ECB), with market expectations favoring earlier and faster rate cuts by the Fed and ECB due to closer inflation alignment with their targets.  

The BoE, lacking a quarterly forecast update or news conference this month, has limited opportunities to shape market rate expectations.  

Some BoE policymakers have advocated for further rate increases — three members of the bank’s Monetary Policy Committee (MPC) voted for a quarter-point rise last month. Chief Economist Huw Pill had also hinted at the possibility of a rate reduction in August 2024, but Governor Bailey emphasized it was "too early to be talking about cutting rates” after the November decision. 

BoE preview: ING says focus on vote split, forward guidance as hold seems certain 

Chris Turner, global head of markets at Dutch bank ING, wrote that investors would be closely watching the vote split at the Monetary Policy Committee, as well as the BoE’s forward guidance, given that the bank was likely to keep interest rates on hold: 

“A keen focus for today's Bank of England meeting will be the vote split. Back in November, there were still three hawks voting for a 25bp hike. The degree to which the vote split softens from 6-3 will impact sterling today. Also in focus will be the BoE's forward guidance and whether it softens its view that policy needs to stay restrictive for an 'extended period'. Shifting this guidance to 'for quite some time' or more dovishly to 'some time' could hit sterling and see UK money markets play catch up with some of the aggressive easing priced into the US and particularly the eurozone money market curves. 

We probably see upside risks to EUR/GBP today, i.e., to 0.8655 or even 0.8685, while GBP/USD should be more supported against the softer dollar. GBP/USD to perhaps trade to the strong side of a 1.2625-1.2685 range”. 

In their BoE preview, analysts at Rabobank said the MPC would likely remain “wedded” to a higher-for-longer stance until it no longer would be viable: 

“We expect the BoE to keep rates on hold at 5.25% for a third consecutive time. A hawkish vote split could signal MPC unease with current market pricing. Having been so unlucky with inflation in 2021/22, we think the MPC will remain wedded to a 'higher-for-longer' strategy until it becomes painfully obvious that this isn’t tenable. Labour is still a seller’s market. It will take time before the labour market weakening we anticipate becomes painful enough to fully uproot inflation. Even as we see a 5.25% policy rate as unsustainably high for the UK economy, we only expect to see the first cut in November 2024.” 

The British pound was slightly weaker before the BoE’s policy announcement, with the GBP to USD exchange rate trading at $1.2662 (up 0.34% on the day). The euro to GBP rate favored sterling, which gained 0.1% against the common currency to trade at 0.8612 as of 10:00 GMT. 

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