An on-consensus event to keep GBP steadyExpect meaningful losses on a holdOne scenario could see GBP/EUR above 1.2050

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Foreign exchange strategists brief their clients on the bearish and bullish scenarios that might come out of a pivotal Bank of England policy day, on which interest rates are widely expected to be raised again.

The market consensus is for rates to rise by 25 basis points, taking Bank Rate to 0.50% and in the process triggering quantitative tightening, whereby the Bank commits to no longer repurchase those bonds on its book that expire over coming months.

For financial markets there is more to the event that could move the Pound and traders will look out for:

| MPC vote composition

| Guidance on future rate rises

| Guidance on quantitative tightening

| Revised inflation forecasts

| Tone

The event therefore promises to offer up some volatility in Sterling exchange rates and it will only be by the close of the day that a clear verdict is delivered by the Pound.

"We think a 25bps hike in February and the start of balance sheet run-off is mostly priced into the GBP," says Stephen Gallo, European Head of FX Strategy at BMO Capital Markets. "We would expect a small confirmation rally in the GBP and a subsequent pullback if the Bank's announcements on Thursday are largely as noted above."

The British Pound has risen through December and January against most of its peers, aided by the surprise decision taken by the Bank in December to hike rates by 15 basis points.

Expectations for follow up hikes have maintained upside impetus into the February meeting taking the Pound to Euro exchange rate to 1.20 and the Pound to Dollar exchange rate trade around 1.35.

"We think the profile skews more negatively for GBP on the day, especially as positioning looks relatively long. That said, external drivers, like risk and the USD, feature prominently in the price action," says James Rossiter, Head of Global Macro Strategy at TD Securities.

Reference rates at publication:

GBP to EUR: 1.1997High street bank rates (indicative): 1.1677 - 1.1760Payment specialist rates (indicative: 1.1890 - 1.1940Find out more about specialist rates and service, hereSet up an exchange rate alert, hereBecause the market has bid Sterling higher into Thursday's decision there is a risk profits are booked when the Bank's Monetary Policy Committee (MPC) delivers a decision that is more or less in line with consensus expectations.

But, should the Bank signal further hikes are likely in follow up meetings weakness might be contained.

Samuel Tombs, ranked the top UK economic forecaster at Reuters and Bloomberg for 2021, is looking for a 'dovish' outcome.

"The MPC warned in November that spare capacity would emerge if rates rose as far as markets expected. The curve is up 30bp since, with no cause for greater medium-term optimism; beware another dovish nudge," he says.

Tombs notes the MPC hasn't hiked rates at consecutive meetings since 2004 and cautiously-minded members might point to November's labour market data which suggest to him employment fell by about 0.3% quarter-on-quarter in the fourth quarter as a reason not to rush.

"We doubt that the MPC's forecasts will validate markets' current pricing, potentially resulting in the clichéd "dovish hike" next week," says Tombs.

Above: Monthly chart for GBP/EUR showing a climb towards the upper end of the post-Brexit vote range.

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Markets are presently positioned for up to 100 basis points of rises over the coming year, which are lofty expectations in terms of the bank's recent history.

The last time Bank Rate was raised by 100 basis points in a year was in 1997 when it went from 6.25% to 7.25%.

An all-out bearish scenario - that would likely see the Pound fall - would be where the Bank foregoes a rate hike completely.

"We expect the Bank of England to hold its policy rate steady at 0.25% at its early February monetary policy announcement," says Nick Bennenbroek, Economist at Wells Fargo.

Given the Bank has a history of surprising against expectations, in November it defied consensus by keeping rates unchanged, market participants will remain wary of such a surprise.

"While elevated inflation will clearly warrant further Bank of England tightening in our view, subdued growth suggests those rate increases will be delivered at only a gradual pace from the U.K. central bank," says Bennenbroek.

Image: Bank of England November 2021 inflation forecast.

Foreign exchange strategists at Credit Suisse meanwhile approach the Bank of England's decision maintaining their bullish stance on Pound Sterling against the Euro.

"There is little choice but to follow through with a rarely-seen consecutive rate hike," says Shahab Jalinoos, Head of FX Strategy at Credit Suisse, observing market-based 10-year inflation expectations are still above 4%.

"The market is near unanimous in expecting a 25bp hike. As far as GBP goes, we remain bulls vs EUR, targeting 0.8275," says Jalinoos. (EUR/GBP at 0.8275 gives GBP/EUR at 1.2085).

"By putting itself in the position of being the G10 central bank with the clearest commitment to active balance sheet reduction through bond sales, the BoE creates in our view a healthy degree of at last psychological support for GBP," he explains.

BMO Capital Markets sees a potentially bullish setup for the Pound occurring if the Bank hike their inflation forecasts higher, implying a need for further rate hikes and proactive stimulus withdrawal in coming months.

"What could potentially send the GBP a good deal higher are the Bank's new CPI inflation forecasts contained within the MPR," says Gallo.

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The analyst notes at the November MPR the Bank forecast CPI inflation moving back under the 2.0% target by the end of 2024.

Gallo says if the Bank were to push the 2024 and [new] 2025 forecasts above 2.0%," we would almost be inclined to view that signal as a 'regime shift' as far as the BoE's views on inflation are concerned".

With regards to Sterling, Gallo says under such an outcome currency markets might view the shift as confirmation of a quick lift-off pace and possibly a higher terminal rate.

"That would be probably be enough to force EURGBP through 0.83," says Gallo. (GBP/EUR above 1.2050, the 2022 high).

Furthermore, if the press conference were to communicate the MPC's willingness to tighten policy at every meeting through June, that might also be enough for support at 0.83 to break says Gallo.

He does however caution it would be very uncharacteristic of the Bank to pre-commit to any type of policy tightening in advance. What we might get instead, is extremely hawkish rhetoric.