Tomorrow we have the Bank of England meeting, where again we expect the central bank to increase interest rates. However, this cycle of hiking we think it starting to come to an end, even though inflation is expected to accelerate above 10% in coming months. The weak state of the UK economy will likely force the BoE to temper down further hikes. So here’s how we think things will play out tomorrow.
A larger hike than previous
In the past few meetings, a 0.25% hike has been voted on by the majority of the MPC. We think there is a strong likelihood of a higher move tomorrow, of 0.5% instead. This move would mirror what other central banks have done over the past month, most notably the US Fed jumping from 0.5% to 0.75% increments, with the Bank of Canada opting for a whopping 1% hike in the July meeting.
A faster pace of tightening would also acknowledge that the MPC are aware that greater action needs to be taken to stem rising inflation. However, we feel this thought is already in the minds of many traders anyway. So we don’t think a 50bps hike tomorrow will really surprise many. If anything, the main risk is if only a 25bps move is decided on. This dovish stance would likely send equity markets higher, while hitting bond yields and the British Pound negatively.
Cost of living crisis hurting
The big focus in our opinion will be concern from the bank about the state of the UK economy. UK GDP for May fell, with inflation rising to 9.4%. This cocktail of no growth and high inflation is known as stagflation and is damaging to an economy.
We don’t see any signs that this is materially going to improve anytime soon, and expect the bank forecasts to indicate this too. Therefore, we think this will cause the committee to advise that future rate hikes will be moderated going forward.
It’s going to be a fine balancing act between trying to stimulate growth (done by lowering rates) and reducing inflation (done by increasing rates). The bank have already pulled rates higher in a short space of time, and an additional 50bps hike would put the base rate at 1.75%. This could be seen as close to the neutral rate going forward, with maybe one more 25bps hike in early autumn.
If this scenario is indicated, we think this represents a negative move for GBP. Even though the currency has weakened already year to date, we see no reason why GBPUSD can’t test the lows again, with EURGBP pushing higher as well.
Trade ideas from here
For stocks, we continue to like banking shares. We think this plays in nicely with the thinking that lower future rate expectations will be positive for stocks, but the existing high rates are also good for banks. The net interest margin that the institutions make is based on the interest rate. The higher this is, the greater the margin charged in the difference between loans and deposits.
In terms of currencies, we favor being short GBPUSD and GBPJPY. The USD should continue the strength seen so far this year, and JPY is a tactical favourite of ours at the moment.