70% chance the Bank of England hikes and keeps guidance unchangedTD Securities says such an outcome could see mild GBP weakness20% chance of a bearish scenario where a halt to the cycle is signalledThis gives 90% chance that GBP ends the day lower, according to TD Securities
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The British Pound's strong run could be faded in the wake of today's Bank of England policy decision as risks are skewed to the downside.
The Bank will likely raise interest rates by a further 25 basis points and commit to further hikes if upcoming data warrants, but analysts at one investment bank say there is a 20% chance the Bank signals it has finished hiking.
According to TD Securities, a bearish scenario for Sterling exchange rates would see the Bank signal it will conditionally pause the hiking cycle to let existing rate hikes work through the system.
"While the latest wages and inflation data came in notably hot, the Committee emphasizes lower inflation expectations, further declines in commodity prices, and uncertainty about financial and banking sector stability as reasons why further rate hikes probably are not required," says James Rossiter, Head of Global Macro Strategy at TD Securities.
The Pound could suffer a fall of approximately 0.60% should investors sense the Bank has delivered its final hike, according to TD Securities strategists.
The Pound also looks stretched ahead of the decision: it is 2023's top-performing major currency, with fresh multi-month highs being printed against both the Euro and Dollar in the hours leading to Thursday's policy decision.
The Pound to Euro exchange rate peaked at 1.1531 in midweek trade while the Pound to Dollar exchange rate reached a new one-year high at 1.2679 following the release of U.S. inflation data.
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Money market pricing meanwhile shows investors are positioned for a further 50-75bp worth of hikes by the summer; more than the U.S. Federal Reserve and the majority of G10 central banks.
The bar is therefore set high for the Bank of England to deliver the kind of 'hawkish' guidance required to boost the Pound; leaving it exposed to downside risks if investors book profits on the gains realised following the recent rally.
"Keep in mind that GBP has a propensity to sell off on BoE meetings since they started to hike last year. Average drop is -0.32% on meeting dates with a much greater skew towards declines than rallies," says Rossiter.
Much will depend on the Bank's updated economic forecasts, particularly the medium-term inflation forecasts. The Pound could come under pressure should inflation forecasts confirm a rapid fall in inflation to 2.0% or below as it signals the Bank believes interest rates are already high enough.
Above: Market expectations for the outlook for the Bank of England's Bank Rate. Image courtesy of Goldman Sachs.
Nevertheless, upside surprises for the Pound could come from any economic growth upgrades, something that the Bank will have to deliver given the economy has outperformed the projections laid out in February.
TD Securities says another upside surprise would involve a change to the Bank's guidance, specifically if the Monetary Policy Committee reintroduces the guidance that it expects "further increases in Bank Rate" will be required if the economy evolves as expected.
Such an outcome could result in an approximate 0.30% uplift in the Pound on the day, according to Rossiter.
But TD Securities holds a base case assumption (70% odds) that the Bank hikes 25bps and leaves guidance essentially unchanged.
"In doing this, the MPC essentially leaves another 25bps hike in June on the table," says Rossiter.
"The vote is likely 6/3 for 25/0, with Cunliffe joining Dhingra and Tenreyro in voting for a hold. Inflation projections will probably be tweaked slightly, though this should have limited policy implications given the substantial uncertainty bands around the projections," he adds.
This base case scenario would potentially see some weakness in the Pound of approximately 0.15%, according to TD Securities.
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