GBP/USD recovered after taking a break during the UK holiday on Monday. Optimism about the upcoming Bank of England decision on Thursday and weakness in the US dollar, have supported the British currency.
The recent disappointing prints for the UK Halifax House Prices for April that dropped to -0.3% from 0.8% previously didn’t affect the currency pair.
On Thursday, the Bank of England (BoE) is expected to increase interest rates to a level not seen since 2008. This decision follows recent official data indicating persistent high inflation.
Positive Brexit news have also lent support to the GBP/USD as EU leaders are willing to improve relations with the UK.
Challenges for the GBP/USD
The GBP/USD currency pair will face challenges ahead of the key BoE meeting and US inflation data, with the ruling Conservative Party experiencing political disappointment in the UK’s local elections and the US Dollar seeing a corrective bounce due to stronger US Treasury bond yields.
US President Joe Biden is preparing to meet with Republican House Speaker Kevin McCarthy, Republican Senate Minority Leader Mitch McConnell, and top congressional Democrats at the White House on Tuesday to discuss a debt-ceiling extension. This meeting has the potential to impact market movements. If US policymakers manage to surprise the markets with a positive outcome and reach a deal to avoid a US default, coupled with the recently optimistic US inflation expectations, the GBP/USD pair may see a retracement of its recent gains near the multi-month high.
Bank of England interest rate hike decision
Market participants are closely monitoring the Bank of England’s (BoE) interest rate policy this week as the central bank gears up for a potential rate hike. Despite the United Kingdom’s inflation showing no signs of slowing down, the BoE has already implemented significant monetary policy tightening measures.
Due to ongoing labour shortages and elevated food inflation, the central bank is anticipated to persist with its tightening measures, aiming to keep the United Kingdom’s inflation within double-digit territory. BoE Governor Andrew Bailey is expected to announce the 12th consecutive interest rate hike, projected at 25 basis points (bps), which would raise the interest rates to 4.50%. Meanwhile, as the Federal Reserve is expected to pause its rate hikes, a move by the BoE to increase interest rates would narrow the policy divergence between the two central banks.
Future interest rate hikes by BoE
The Monetary Policy Committee (MPC) is determined not to limit its options and exclude the possibility of future interest rate hikes. It is expected that officials will emphasise the importance of data in guiding future interest rate decisions, indicating that there is no particular bias towards further tightening or reversing the current policy and lowering rates.
MPC members have grown increasingly concerned about the potential risks of a wage-price spiral. Recently, Huw Pill, the Bank of England’s chief economist, advised households and companies to come to terms with the fact that higher energy prices will negatively affect their finances. Central bank officials have been closely monitoring pricing decisions made by companies.
Ashley Webb, a UK economist at Capital Economics, suggested that instead of discouraging pay raises or profit margin protection, the MPC should have emphasised the need to make borrowing more expensive for both companies and households.
Given the prevailing uncertainties, it is likely that the MPC will address the risks associated with its decision on interest rates.
The BoE is not expected to indicate a need for future rate increases, but market participants anticipate further tightening. The futures market suggests that borrowing costs will end the year at nearly 5%.