Pound Gains Ground Against its Peers As BoE Lifts Rate Unexpectedly

December 16, 2021
Pound Gains Ground Against its Peers As BoE Lifts Rate Unexpectedly December 16, 2021 Lennox Hamilton

The Bank of England increased its key interest rate by 15 basis points to 0.25 percent, prompting a rally in the British Pound. In the seconds after the news, the pound sterling was half a percent higher versus the euro and three-quarters of a percent higher against the US dollar.

The Monetary Policy Committee (MPC) increased Bank Rate by an 8-1 vote, which might be seen as a positive signal for Sterling, as highlighted in our preview piece. Gains were recorded versus all major rivals, indicating that a sizable portion of the market was unprepared for the move, anticipating policymakers to defer in light of mounting Coronavirus infections in the United Kingdom.

However, the Bank could no longer ignore the threat of skyrocketing inflation, which has already surpassed its 2.0 percent objective and risks settling over target in the longer run.

“The pound has soared to new heights. The market has basically factored in the possibility of an increase. This is surprising in light of the recent Omicron assault. Investors have mostly accepted the bank’s decision to postpone rate rises until 2022. The pound should maintain its strength throughout this shift,” according to Neil Jones, currency broker at Mizuho Bank. The Bank said in a statement that “the MPC’s mandate is clear: the inflation goal must be met at all times, underlining the centrality of price stability in the UK’s monetary policy framework.” As a result, although they recognised the expansion of Omicron and the related hazards, they were compelled to respond to inflation.

“Clearly, the Bank of England is focused on inflation, even when it comes to the omicron variant’s effect. This demonstrates that the central bank is quite worried about price stability,” says Bernd Weidensteiner, Commerzbank’s Senior Economist. Specifically, Bank analysts observe a high increase in the inflation basket’s core components; this is an explicit reference to the portion of inflation that the Bank may evaluate.

“There has been strong positive news in core goods inflation and, to a lesser degree, in services inflation. Bank officials anticipate inflation to continue around 5% for the duration of the winter and peak at roughly 6% in April 2022,” the statement said.

Additionally, additional rate rises seem to be on the horizon: “It would be essential to raise Bank Rate in the coming months in order to sustainably bring CPI inflation to the 2% objective,” the statement stated.

The action establishes the Bank of England as the first mover on interest rates among its major peers, which could benefit the Pound, especially against currencies controlled by central banks that are expected to hike slowly.

“Despite this morning’s PMI statistics and the huge increase in Covid cases, the Bank of England is certainly justified in raising interest rates soon before Christmas.”

Given high and rising inflation, in part as a result of the Bank’s communication blunders that resulted in a de facto weaker sterling policy, it clearly felt it couldn’t continue to press the accelerator pedal despite the risks now present in the economy,” according to Hinesh Patel, portfolio manager at Quilter Investors.

Recognizing that UK economic development will likely decelerate as a result of the Omicron variant’s spread, Bank analysts cut down their fourth-quarter GDP growth forecast to 0.6 percent from 1% at the time of the November Report. Bank analysts now predict GDP in Q4 to be around 112 percent lower than in Q4 2019.

However, and perhaps most significantly, Bank analysts now anticipate the UK’s unemployment rate to decline to about 4% in the fourth quarter, compared to the 4.50 percent prediction in the November Report. As such, the MPC recognised that upside risks to wage pressures were becoming more pronounced.

Senior Adviser at Cambridge Econometrics, Andrew Sentance, described the move as “one little step toward more reasonable monetary policy.” The MPC votes 8-1 to increase interest rates to 0.25 percent. “A little step forward, perhaps followed by others in 2022.”

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