The British pound faces a crucial test as the Bank of England (BoE) prepares to announce its November interest rate decision. The outcome could significantly influence the pound's value, but several factors come into play.
If all members of the Monetary Policy Committee (MPC) vote to maintain the current interest rate, and there are no substantial alterations to inflation and growth forecasts, the pound may remain relatively unaffected. This decision aligns with market expectations and is unlikely to cause significant ripples in financial markets.
However, for forward-looking observers, the key focus will be on the guidance provided in the policy statement and the forecasts outlined in the Monetary Policy Report.
Some market sentiment suggests that the BoE might aim to maintain its 'high-for-longer' message, ensuring it remains the primary takeaway from November's policy statement. Such a message could lend support to the pound.
In recent times, there have been no upward adjustments to the base rate, accompanied by indications that rate cuts are not on the immediate horizon. This message may offer some upside for GBP, especially given the already modest expectations for further tightening.
This contrasts with previous scenarios where the euro experienced gains against the British pound. Although the euro remains at a higher level against the pound compared to the previous week, the pound's depreciation has started to stabilise.
To convey the 'higher-for-longer' message effectively, the composition of the MPC vote and the economic forecasts are critical factors.
The market anticipates a significant majority favouring the status quo, but any potential downside risk for GBP could emerge if Swati Dhingra, the most dovish member of the MPC, votes for a rate cut. This would signal a shift toward discussions about rate cuts. However, the pound's response would depend on the broader context and any accompanying discussions highlighted in the minutes.
Economic forecasts hold substantial importance as the MPC uses them to guide market interest rate expectations, which, in turn, affect borrowing costs and the exchange rate. The inflation forecast for 2025 is of particular importance. For instance, if forecasts indicate that inflation will dip below the 2.0% target by 2025, it implies that the Bank might consider interest rate cuts starting around 2024. The adjustments to these forecasts can influence expectations in the market.
As a rule of thumb, upgraded growth and inflation forecasts signal the BoE's commitment to maintaining higher rates for an extended duration. Conversely, downgrades to growth and inflation predictions can erode the strength of such guidance, potentially leading to softer pound value.
If this forecast, which currently falls below the target, experiences an upward revision, it could provide additional support for the pound. However, this might also exert downward pressure on UK bond yields and potentially lead to a weaker pound.
In the grander scheme of things, the UK's economic situation is comparatively better than what was anticipated earlier this year and more favourable than the projections for the eurozone in the near future. The latter is increasingly seen as approaching a potential recession, while the UK has managed to avert such a scenario, despite grappling with high inflation for an extended period and the economic challenges posed by the cost of living crisis during 2021 and 2022.
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