Bank of England rate decision: implications of rising sales and monetary policy

Observers in the UK are likely to welcome a limited data calendar and moderate movements in sterling, as expectations build ahead of the Bank of England’s next rate decision.

This morning, the only relevant UK-specific data release was the British Retail Consortium’s like-for-like sales figure, known as the BRC, which rose to 5.2% in April from 4.9% in March.

Although, at first glance, the increase in sales could suggest that the British consumer remains resilient, this data coincided with an increase of around 10% in benefit payments for most recipients. In the context of these households having recently received higher income, this moderate rise in the data actually points to a weakening in consumer demand, as restrictive monetary policy begins to take effect.

This is encouraging news for the Bank of England, whose monetary policy meeting results will be announced on Thursday. Consensus expectations indicate that the Monetary Policy Committee, known as the MPC, will raise Bank Rate by 25 basis points at the next meeting. However, expectations diverge beyond that point.

Currently, swap markets are pricing in an additional 41 basis points of rate hikes after the May meeting, while economists generally expect the Bank of England to keep rates unchanged after the upcoming increase.

This difference in expectations is unlikely to be resolved by the Bank of England in its upcoming communications. Instead, we expect the Bank to signal its willingness to pause, while keeping the door open to further hikes if the data justifies them.

This approach would be in line with the stance adopted at the March meeting and would mirror the message delivered by the Federal Reserve last Wednesday, making it easier for markets to interpret. However, there is a risk that the Bank of England adopts a definitive stance in one direction or the other.

If this happens, the current gap in expectations suggests that significant volatility in sterling could follow the rate decision. Our view leans toward a more likely announcement of an explicit pause in rate hikes, which would probably trigger a sharp fall in the value of the currency.

Implications of ECB and Federal Reserve decisions for the eurozone

The similarities between last week’s decisions by the European Central Bank, ECB, and the Federal Reserve have highlighted the “divergence” trade that had supported eurozone assets over the past two months.

In the specific case of the euro, this led to a widening of the interest rate differential between the United States and the eurozone, which had been the main driver behind EUR/USD reaching a one-year high. As a result, the euro has struggled to move back toward that one-year high and has remained within a relatively narrow range.

Speculation is also growing that the broad euro rally is coming to an end. Although we tend to agree that the pace of euro appreciation is likely to slow as the ECB adopts a more cautious approach to tightening monetary policy, with interest rates approaching their terminal level, we believe the market is underestimating the likely endpoint of the ECB’s hiking cycle, currently priced at just 3.5%.

Although new eurozone inflation data will probably be needed for money market traders to revise their expectations higher, in the meantime we expect ECB officials to continue supporting a longer hiking cycle than markets are currently pricing in.

Most recently, this sentiment was expressed by Chief Economist Philip Lane, who highlighted upside risks to inflation due to the momentum in core inflation.

With several ECB members scheduled to speak today, this message is likely to be repeated, especially by prominent ECB member Isabel Schnabel, known for her consistently restrictive stance over the past six months.

While this could provide some support for the euro, any volatility in EUR/USD is likely to come more from US inflation data, which is due to be released tomorrow afternoon.

As for our overall outlook, developments over the past week have had little impact on our medium-term view.