- The BOE has surprised by raising rates in December, a decision unaccompanied by a presser.
- Officials in London are following their hawkish counterparts in Washington.
- Worsening covid conditions and a "stealth" lockdown could still depress the pound.
"Unreliable boyfriend" has been the derogatory term used against Bank of England Governor Andrew Bailey. He seems to be living up to that image of not being trustworthy – raising rates without communicating it in advance. That contrasts last month's surprise "no-change." While sterling's leap looks justified, it could prove temporary.
The official justification for raising rates from 0.10% to 0.25% has been the leap of inflation from 4.2% to 5.1% in November, beating expectations. That figure came out only on Wednesday and may have tipped the scales. The labor market is also doing well, as employment remains robust despite the end of the furlough scheme.
However, perhaps the most significant trigger for the BOE's move comes from over the Atlantic – the Federal Reserve doubled down on tapering and signaled no fewer than three rate hikes in 2022. That was a hawkish decision, and markets received it better than expected.
Bailey may have looked at the market reaction and thought to give it a go. It is essential to remember that the 15bp rate increase still leaves borrowing costs below pre-pandemic levels.
GBP/USD has leaped by some 80 pips, fully justified given the 40% chance for a move. However, this is unlikely to last.
Once the dust settles from the BOE surprise, markets could return to covid and its grim state in the UK. Britain reported over 78,000 cases on Wednesday, a record. Warnings of hospitals filling up could materialize given the rapid contagion pace.
It does not necessitate an official lockdown – which Prime Minister Boris Johnson rejects – to slow the economy down. The mere scary headlines, restrictions on travel and worry could keep consumption depressed. That would weigh on sterling and also push the BOE to pause before the next move.
Overall, this rapid increase in the pound's value, however, justified, could prove to be the high watermark.
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