GBP under pressure ahead of Bank of EnglandRisks of a 25bp hike have grownBoE to signal an end to rate hikes is closeBut Oxford Economics says no cut in 2023Which could yet offer GBP downside protection

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The British Pound is at its lowest level against the Euro since September 2022 as investors anticipated another 'dovish' outcome from today's Bank of England interest rate decision and Monetary Policy Report

The Bank is expected by markets to raise interest rates by 50 basis points, but expectations for a 25bp have risen amidst fresh signs the UK economy is slowing under the weight of previous rate hikes, a development that has weighed on the Pound.

"We would not be that surprised if the BoE delivered a smaller 25bps hike," says Derek Halpenny, Head of Research Global Markets EMEA at MUFG.

As currency analysts note, any such move would prove to be a 'dovish' development that would likely result in Pound weakness.

"We believe that [the] BoE policy meeting poses downside risk for the GBP," says Halpenny.

The Pound to Euro exchange rate trades at 1.1213, levels last seen in the wake of former Prime Minister Liz Truss' failed mini-budget, but the Pound to Dollar rate remains supported owing to a 'dovish' Federal Reserve policy update overnight.

A 50bp hike remains a base case expectation for investors, however, Sterling could still prove volatile on the nature of the guidance given by the Bank on future interest rate developments.

"The biggest event risk for sterling over the coming months is when the Bank of England calls time on the tightening cycle. We are looking for a 50bp hike next week and then a 25bp hike in March to conclude the cycle at 4.25%," says Chris Turner, who heads FX research and strategy at ING.

Turner explains that at some point the Bank will have to signal the top and ING has already seen investors lose conviction over a peak in the cycle at 4.50%.

MUFG's Halpenny says Bank officials, including Governor Bailey, have recently welcomed evidence showing inflation is turning a corner and natural gas prices have continued to fall sharply which will help ease inflation and growth concerns if sustained.

MUFG expects the accompanying guidance to be more dovish by providing a stronger signal that the pace of hikes will be stepped down and they are moving closer to a peak for rates.

"A dovish surprise could come from a simple message that the end of the rate hike cycle is close as the central bank has to focus on long and variable lags of monetary policy. In this scenario, the market is likely to accelerate the pricing of cuts in '23 and '24," says Anna Titareva, Economist, at UBS.

The peak for Bank Rate is now priced at around 4.37% as investors lower expectations, a development that has been tracked by a softer British Pound.

"There is probably substantial short sterling positioning on the crosses in expectation of the turn in the BoE cycle. This makes for a bumpy ride," says Turner.

ING holds a forecast for EUR/GBP at 0.89 for the end of the first quarter, which gives a Pound to Euro target at 1.12.

Their call for the Pound to Dollar is for a move to the lower end of the 1.20-1.24 range.

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Following the release of softer-than-expected UK PMI data for January market bets for a 2023 rate cut from the Bank of England has grown, something we note could prove a potential downside drag on Pound Sterling value.

These expectations were further cemented on Tuesday after the Bank's official lending data showed a sharp decline in lending as consumers responded to higher interest rates, indicating that previous cuts are having a material effect on the economy.

House purchase mortgage approvals fell to 35.6K in December, from 46.2K in November, putting it on a par with the financial crisis lows of 2009. The net flow of consumer credit was £0.5BN in December, down from £1.5BN in November, and lower than the previous 6-month average of £1.2BN.

The net flow of sterling money decreased to -£34.7BN in December, from -£24.0BN in November.

"December’s money and credit figures revealed that higher interest rates further dampened economic activity at the end of last year. Moreover, the drag on activity will continue to intensify this year as the Bank of England raises interest rates," says Ashley Webb, UK Economist at Capital Economics.

Above: Bank Rate and average mortgage rates (%). Sources: Refinitiv, Capital Economics. Image courtesy of Capital Economics.

Andrew Goodwin, Chief UK Economist at Oxford Economics says the Bank cannot yet afford to rest and sees the peak in Bank Rate in the 4%-4.25% range.

This would leave the MPC comfortable that it had struck the right balance between bearing down on inflation, while not hurting activity excessively, says Goodwin.

"Sticky core inflation means we think rate cuts will have to wait until 2024," he adds.

Such an outcome would potentially support the Pound as it would push back against the recent weakness triggered by expectations for a 25bp cut before year-end.