GBP limping after BoE reminds of uncertaintiesSays 1970s style income squeeze dims outlookCould reduce inflation and constrain Bank RateMay CPI forecasts key to medium-term outlook Two-side risks for GBP from all decisions ahead

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Pound Sterling was left trading with a limp against the Euro, Dollar and other currencies early on this week after Bank of England (BoE) Governor Andrew Bailey reminded financial markets of what is increasingly an uncertain outlook for Bank Rate.

Sterling was nursing wounds on Tuesday after coming under pressure in the wake of earlier remarks from BoE Governor Andrew Bailey in a discussion about macroeconomic and financial stability at Bruegel, an economic policy think-tank.

Governor Bailey said the big squeeze on incomes generated by recent increases in prices of commodities and other goods is on a par with that seen in any single year of the 1970’s and reminded that this could reduce the extent to which interest rates need to be lifted further in the months ahead.

We are now in a Q&A session with Andrew Bailey, Governor of @bankofengland. Ask your questions on https://t.co/b3dK2nnsxt using #stability https://t.co/CuTkGyGUXB

— Bruegel (@Bruegel_org) March 28, 2022“We’re facing a very big shock by any historical standard. We’ve got a very large trade off between inflation and output and activity, with the two moving in opposite directions. There is a very high level of uncertainty,” Governor Bailey said at one point on Monday.

“The point I want to make here is that in these circumstances, policy guidance looking forwards should recognise the uncertainty we face and the risks we face and it’s really with that in mind that we changed our language at our last meeting to state that ‘some further modest tightening may be appropriate’ rather than ‘is likely to be appropriate’ as we’d used before,” he added.

Above: Pound to Euro rate shown at hourly intervals alongside GBP/USD. Click image for closer inspection

While expectations for Bank Rate later were scaled back following the BoE’s March policy statement, pricing in the overnight-indexed-swap (OIS) market still implied on Monday that a further increase in Bank Rate from 0.75% to 1% is all but certain for May.

“There is only one prediction I can safely make and that is there will be a meeting in May,” the governor also said.

Financial market pricing also envisages Bank Rate rising further to two percent or more before year-end, which is an assumption that is likely to be stress tested in the near future if the BoE’s recent language and Governor’s remarks on Monday are anything to go by.

The BoE said on March 17 that inflation is likely to reach 8% by April and warned this would sap demand from some parts of the economy, while Governor Bailey reminded Monday that this dynamic could eventually reduce domestically-generated inflation.

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“Sterling has held up well following the BoE’s softening of guidance and positive April seasonals may lend more support over the coming month. Our bias is to sell into any EUR/GBP rallies [buy into GBP/EUR dips],” says Paul Robson, EMEA head of G10 FX strategy at Natwest Markets.

Governor Bailey’s remarks and the BoE’s recent language mean the next round of economic forecasts will be doubly important, and especially whether or not inflation is seen falling further beneath the two percent target at the end of the forecast horizon.

The latter could lead the commodity-induced squeeze on incomes to be viewed as a substitute for some of the interest rate rises that have all but been taken to the bank by the markets of late, and would be why each of the BoE’s forthcoming policy decisions poses two-sided risks to Sterling.

“We think the MPC would like to get at least 1-2 rate hikes in before pausing,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

Above: Pound to Euro rate shown at daily intervals with selected moving-averages.Click image for closer inspection.