Bank of England meeting – hawkish shift on the way?

Now that the UK and EU have moved towards a transition deal, the outlook for the Bank of England meeting this week has changed.

Bank of England
Source: Bloomberg

This week’s Bank of England (BoE) meeting may well take on a different hue if the Brexit deal, discussed on Monday, represents a meaningful development between the UK and EU. The potential removal of a major headwind for the UK economy means that a rate increase may actually be more likely.

In September the bank was at pains to carefully prepare the groundwork for a move in November, but a repeat performance of this is unlikely. Having broken the taboo, the bank will feel less need to treat investors with kid gloves.

Much will depend on the consumer price index (CPI) reading, expected tomorrow. CPI is forecast to be 2.8% year-on-year, from 3% a month earlier, while the core figure is also forecast to weaken to 2.5% from 2.7% on an annual basis.

Another hike in May seems likely, but beyond that the market appears relatively complacent. Indeed, it seems to be underrating the chances of a more aggressive policy response from the BoE later in the year.

A transition deal between the UK and the EU would likely remove a source of uncertainty for UK businesses, and the economy generally, and should be viewed as a positive for GBP/USD.

It certainly is a big week for the pound, given that we have CPI and employment and wage data before the committee meets. So even with no change to rates this month, the language of the committee may turn more hawkish. Unlike the US, where extra slack (spare capacity in the economy) has suddenly appeared, the UK appears to have less room for growth in employment. Still, the statement may shift in a more hawkish direction now that a transition deal has been agreed.

The news of the deal prompted GBP/USD to rally to its strongest level in a month, although a close above $1.4070 still eludes the pair. Further gains will target $1.4145, and then on to $1.4345, the January peak. A turn lower would target $1.3836 and then $1.3659.

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