BOE Interest Rate Decision Preview: A hat-trick and a difficult balancing act

The Bank of England (BOE) is eyeing a hat-trick, with the third straight 25 basis points (bps) rate hike at its March monetary policy meeting this Thursday. Russia’s invasion of Ukraine has thrown the central bank in a dilemma as it attempts to combat inflationary pressures while maintaining economic growth.

BOE caught between a rock and a hard place

The BOE is widely expected to raise the benchmark interest rate by 25 bps from 0.50% to 0.75% in its March monetary policy meeting, marking a lift-off for a third consecutive meeting.

It’s not a ‘Super Thursday’, as there is no Governor Andrew Bailey’s press conference, leaving markets focussed on the voting composition for a rate hike as well as Bailey and Co.'s statement on the policy outlook. The economic forecasts will be of little relevance as they were prepared before Russia invaded Ukraine.

In its February meeting, the British central bank unanimously increased rates by 25 bps to 0.5% – the first back-to-back hikes since 2004 – and hawks were joined this time by December’s lone dove, Silvana Tenreyro. As the rate hike itself was already priced in it did not come as a surprise to markets, however, the vote hike composition did deliver a significant hawkish surprise, with four of the nine voting members, Ramsden, Saunders, Haskel and Mann, all in favor of a 50 bps move in rates. 

It remains to be seen if the BOE delivers a hawkish or dovish rate hike this month, as Bailey is put in a fix, courtesy of the Russia-Ukraine war.

Heading into the decision, the UK’s annualized inflation stands at the highest level in 30 years at 5.5% and is no longer seen peaking at 7.5% in April, as the Ukraine crisis shot energy prices through the roof, with oil prices up roughly 25% so far this year. We may see inflation pump even higher.

Meanwhile, wages jumped 4.8% YoY in January, underscoring concerns that higher inflationary conditions may get entrenched, which could prompt policymakers to act more aggressively now than before.

Acting too aggressively, however, could provide the biggest risk to the growth outlook, as warned by policymaker Tenreyro earlier this month. She said that the latest rise in oil prices will increase inflation and dampen UK economic activity.

Therefore, all eyes will remain on the BOE’s future rate hike plans, as it attempts to balance inflation and growth concerns. The market pricing is for interest rates to reach 2% by the end of this year.

GBP/USD probable scenarios

If the BOE follows in the hawkish footsteps of the European Central Bank (ECB) by hinting at probable rate hikes in each of its upcoming meetings, the pound could receive some much-needed respite. GBP/USD could then extend its recovery momentum from the lowest level since November 2020.

The ECB, at its last policy meeting, announced accelerated tapering of bond purchases, in an unexpectedly hawkish shift while acknowledging the uncertainty due to the Ukraine crisis.

Cable may resume the downtrend should the central bank adopt a flexible approach, leaving options open, dependent on the geopolitical developments and incoming economic data. The pound may also be hit by less hawkish dissent (vs. seen in February) if fewer policymakers now see the need for a 50 bps hike.

Although it's also worth noting, GBP/USD’s reaction to the BOE outcome could also be influenced by near-term factors such as the prevalent risk trend going into the meeting, in the wake of the Ukraine saga and the Fed’s policy decision on Wednesday, March 16.