What should traders expect after the Bank of England says no to UK rate hike?
Yesterday the MPC voted by a margin of 8 to 1 to maintain the UK base interest rate at 0.5%. Further, the asset purchase programme will also be kept at £375 billion. So what does this mean for traders, and how does the MPC’s decision affect the currency markets?
Inflation remains beneath the crucial 2% target
The Bank of England’s Monetary Policy Committee (MPC) met on 9 September 2015 to decide whether UK interest rates would be raised from their current level of 0.5%. Voting 8-1, policymakers decided against hiking rates in the UK at this time. The lone voice of dissent was Ian McCafferty. Of equal importance, the MPC chose to maintain stock purchases of £375 billion in the asset purchase programme.
This month’s decision is attributed to several factors, namely:
- The MPC believes that growth is trending lower, owing to weakness in China and high risk factors in the eurozone
- 12-month CPI inflation increased by just 0.1% through July, well below the targeted 2% inflation rate
- MPC members are of the opinion that when the bank rate increases, it should be done in a gradual way at lower levels
The overall consensus of analysts has come to pass. In recent days, weak PMI manufacturing data and weak PMI service data were released, and the GBP/USD currency pair retreated on the back of those poor reports, as the euro strengthened against sterling. However, there has been a strengthening of GBP since the BoE decision. Indeed, there is no pressure at this point in time to raise interest rates in the UK.
Rate hikes are good and bad for the UK
Rate hikes can be viewed in different ways. A rate hike makes the British pound inherently more attractive to foreigners. By raising the bank rate, the yield on GBP-denominated savings and investment accounts increases. This means that more currency will be exchanged for GBP. This has the effect of increasing both the demand for and the strength of GBP in currency markets. This scenario did not come to pass. Despite the absence of a rate hike, markets tend to move more in line with forecasters’ predictions rather than actual results. In this particular instance, forecasters were on the money and GBP was positively impacted.
There is the flip-side of the coin too: when the bank rate increases, domestic consumers suffer. Since mortgages in the UK are variable, a bank rate increase would make the cost of credit that much more expensive. Long-term debts, short-term debts, bank loan rates, company debts and other credit facilities would all become relatively more expensive for UK residents and citizens.
Therefore a rate hike is not necessarily viewed positively by the citizenry. It does however assist in moving towards the inflation target of 2%, provided that the overall health of the UK economy is strong. Against the backdrop of burgeoning global pressures related to the China crash, it is perhaps not the best time to raise interest rates in the UK.
GBP and the Bank of England decision
The GBP/USD currency pair appreciated after the news release, trading at 1.5454 (+0.56%). The EUR/GBP currency pair lost ground and was trading at 0.72855 (-0.09%). It is entirely possible that we could be looking at a deflationary scenario in coming months. Inflation will remain weak and wage costs will continue to be sticky, but the decision of the Bank of England at this time was the right one. As we project ahead, a rate hike taking place in February 2016 seems the more likely prospect. In preparation for this, traders might wish to go long on GBP and short on EUR ahead of this decision.
Prior to the announcement by the Bank of England, there was a majority bullish sentiment for the pound, although buy orders decreased by several percentage points. The GBP/USD currency pair traded between 1.5339 and 1.5476 on 10 September, and GBP has been appreciating since September 7 when it was trading at 1.5194 to the dollar.
Presently the right short-term trading decision would be a call option on GBP based on prevailing trader sentiment. That only one hawk voted in favour of raising interest rates is important, as a greater number would certainly have generated more GBP demand. It will be interesting to see if the 8-1 ratio changes by the next meeting.
Bank rate projections
Economic growth prospects in the UK will determine which way the MPC will move in the coming months. It is clear that the labour market and general economic growth is strong in the UK; however poor PMI data in services and manufacturing is quite alarming.
The more pressing concern is how China will emerge from its current quagmire and how commodities prices and emerging market economies will react to decreased demand from the world’s second-largest economy. The likelihood of higher interest rates in the UK remains the shared opinion of analysts. Within a year a rate of 1.25% is expected, and thereafter an increase to 2% for 2017 and perhaps 2.5% by 2018.
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