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The Bank of England would need to raise Bank Rate by 50 basis points today if Pound Sterling is to gather support, according to analysts.

The calls follow news on Tuesday that UK core inflation rates reached a new record and headline CPI inflation beat expectations for the fourth month in a row, raising concerns the Bank of England has failed to recognise the seriousness of the UK's inflation problem.

By raising interest rates by 50bp it would be stepping up a gear from the recent run of 25bp moves and signalling a growing determination to ensure inflation expectations do not become more embedded to the extent it misses its 2.0% inflation target in the long run.

"Finger-pointing and a small hike could prove devastating for sterling. In short: the market has already priced 90 basis points through the next three meetings, so to clear the expectations bar, the BoE may need to hike 50 points and hawkish guidance to support sterling again," says John Hardy, FX Strategist at Saxo Bank.

Above: Interest rates matter for the Pound. Image courtesy of BMO Capital.

Following the midweek inflation release money market data showed investors moved to price in an additional 160bp worth of rate increases in total, up from 140bp yesterday.

For today's meeting, markets price in a 60% chance of a 25bp rate hike but a 40% chance of a return to a larger 50bp step change. Some interpretations of money market signals suggest the odds of a 50bp move are now actually as high as 50%.

"We now expect the MPC to raise interest rates by 50bps to 5.00% at tomorrow’s meeting," says Neil Shearing, Group Chief Economist at Capital Economics.

Typically above-consensus inflation data would boost UK bond yields and raise the value of Pound Sterling, but both yields and the currency traded lower, suggesting perhaps the UK inflation/Bank of England dynamic is well understood by the market and the trade has reached saturation point.

The prospect of any further rise in rate hike expectations looks limited, says Francesco Pesole, FX Strategist at ING Bank, suggesting much of the higher-for-longer hike story might be well understood by the market and incorporated into the value of the Pound.

"The room for a further hawkish repricing in the Sonia curve is limited and so are the positive implications for sterling of more data surprises," says Pesole.

But the data could also suggest the market is looking beyond interest rate differentials (which powers the so-called carry trade) and is concerned about the UK's growth prospects in the face of higher interest rates and persistent inflation.

Above: UK inflation is being underpinned by strong inflation in the services sector. Image courtesy of Berenberg Bank.

If true, the Pound could be destinated for weakness, regardless of which way the Bank swings.

(But sellers beware: the Pound also fell in response to May's consensus-busting inflation release only for the Pound to Euro exchange rate to rally to a new ten-month high and the Pound to Dollar exchange rate pushed to a 14-month high in June.)

Stephen Gallo, Global FX Strategist at BMO Capital Markets, says the Bank faces two options.

The first is to deliver "further cautious tightening" (another 25bp move and broadly unchanged guidance), and hope that inflation and a wage-price spiral cause a slowdown on their own.

"The second option seems like the better route, and it favours 50bps from the BoE," says Gallo, warning the inflation surprise means there is a heightened risk a 25bps rate hike "causes a backup in longer-term yields and a fall in GBP".

He adds that if the Bank isn't restrictive enough - by going with 50bp - it risks "worsening the UK trade deficit, considering how tight the UK labour market is".

"The consensus remains for a smaller increase, but the markets are pricing in a 50% chance of a larger move. Accordingly, a failure to deliver could cause financial conditions to loosen and the pound to weaken, which is the last thing that policymakers at the Bank need right now," says Shearing.

Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole, also warns of a potential downside reaction in the Pound if the Bank of England strikes the wrong tone.

"The GBP remains the best-performing G10 currency so far in 2023, mainly because investors believe that the BoE is the most hawkish G10 central bank," he says. "With so much to live up to already, we worry that the BoE will disappoint the very hawkish market expectations on Thursday and thus encourage investors to take profit on their long GBP positions."

Above: The Bank of England has overestimated the speed at which inflation will fall. Image courtesy of Berenberg Bank.

But another consideration for the 50bp club would be the risk the Bank looks panicked; after all, such a hike would be an admission its approach and expectations regarding inflation had been wrong for an extended period.

Cathal Kennedy, Senior UK Economist at RBC Capital Markets, says the risk of overtightening given the lags in monetary policy and the risk of looking 'panicked' this late in the hiking cycle, leads him to think a 25bp hike will be forthcoming.

Any suggestion the Bank is losing control could also result in a strong weakening of the Pound.

Complicating an already complicated situation is the view of Derek Halpenny, Head of Research for Global Markets EMEA at MUFG, who says an aggressive 50bp move would help the Pound, but the impact would be limited.

"We lean slightly more in favour of 50bps now given this terrible inflation print. Like before, more aggressive action should help boost GBP near-term but investor concerns will likely build over the growth implications which will limit the scale of appreciation at higher levels," he says.

There are therefore a number of variable parts to consider heading into today's policy decision, but what is clear is the Bank has no easy options and the currency market remains unsure of how to play the currency in the current environment.

Volatility is therefore likely, but for now, it looks like anything less than 50bp would prove unsupportive of the Pound, which remains 2023's high flyer going into the policy announcement.