Bank of England’s Rate Decision: Implications of Sales Increase and Monetary Policy
Observers in the United Kingdom will be pleased with the sparse data schedule and moderate price movements in the British pound, as anticipation grows for the forthcoming Bank of England rate decision. This morning, the only specific UK data point of note was the release of like-for-like sales data from the British Retail Consortium (BRC), which increased to 5.2% in April from a reading of 4.9% in March.
While the rise in sales might suggest a resilient British consumer at first glance, it coincided with a roughly 10% surge in benefit payments for most recipients. In the context of these newly affluent households, this modest increase in the data actually implies weakening consumer demand as tight monetary policy begins to have an impact. This is encouraging news for the Bank of England, whose policy meeting results are scheduled to be announced on Thursday. Consensus expectations indicate that the Monetary Policy Committee (MPC) will raise the Bank Rate by 25 basis points at the upcoming meeting, but there is a divergence in expectations beyond that point. Currently, swap markets imply an additional 41 basis points of rate hikes following the May meeting, whereas economists, on the other hand, generally expect the Bank of England to hold rates steady after the next hike.
This disparity in expectations is unlikely to be resolved by the Bank of England in their upcoming communications. Instead, we anticipate the Bank to signal a willingness to pause while remaining open to further hikes if the data suggests it is warranted. This approach would align with the stance taken at the March meeting and echo the messaging of the Federal Reserve last Wednesday, making it easier for the markets to digest. However, there is a risk that the Bank of England could take a definitive stance one way or the other. Should this occur, the current expectation gap suggests that significant volatility in the pound could follow the rate decision, with our view leaning toward a more probable announcement of an explicit pause in rate hikes, likely triggering a sharp decline in the value of the currency.
The Implications of ECB and Federal Reserve Decisions on the Eurozone
The similarities between the European Central Bank (ECB) and Federal Reserve decisions last week have exposed the “divergence” trade that had been favorable for eurozone assets over the past two months. Specifically for the euro, this led to a widening of the spread between US and eurozone interest rates, which had been the main driver for EURUSD reaching a one-year high. Consequently, the euro has struggled to retrace to its peak from a year ago and has traded within a relatively narrow range.
There is also growing speculation that the broad rally of the euro is nearing its end. While we tend to agree that the pace of euro appreciation is likely to slow down as the ECB adopts a more cautious approach to tightening its policy with interest rates approaching their terminal level, we believe that the market is underestimating the probable end point of the ECB’s hiking cycle, currently priced at just 3.5%.
Although it may require further inflation data from the eurozone for money market traders to revise their expectations upward, in the meantime, we expect to see continued support for an extended hiking cycle compared to what the markets are pricing in from ECB officials. Most recently, this sentiment has been expressed by Chief Economist Philip Lane, who emphasized the upside risks to inflation given the momentum in core inflation.
With several ECB speakers scheduled for today, this message is likely to be reiterated, especially by prominent ECB member Isabel Schabel, known for her consistently hawkish stance over the past six months. While this could provide some support for the euro, any volatility in the EURUSD pair is more likely to stem from US inflation data scheduled for release tomorrow afternoon. Regarding our overall perspective, the developments of the past week have had little impact on our medium-term outlook.