Will the BOE hike by 50 basis points?

The BOE will announce its policy decision later today. Here is a brief primer on what to expect, and why the stakes are high that the BOE will join other central banks and may choose to hike rates by 50bps.

The reasons to hike rates by 50 bps:

·      It looks like there is an implicit coordination between major global central banks to hike interest rates in an aggressive manner to stamp out global inflation. If major central banks (ex. the BOJ, for now) all surprise the markets together, then there could be less volatility in FX markets. Thus, there is pressure for BOE to follow the SNB, the RBA, the Reserve Bank of India and the Fed by hiking interest rates by 50 bps later today.

·      Some may argue that this would have a negative impact on the UK economy and thus the BOE couldn’t justify such a move. However, the UK economy could adjust to a larger rate rise because the transmission between interest rates and household finances has weakened since the last rate-hiking cycle. There are fewer mortgaged householders (due to the baby boomers having already paid off their mortgage), and because more people are on fixed-rate mortgages than in the past.

·      There is a fear in the FX market that the pound could come under sustained pressure, a bit like the yen, as the FX market turns on sterling due to a toxic mix of a weak economic outlook, a high current account deficit and a weakening interest rate differential with other countries. The BOE will want to avoid a sterling crisis, if possible, as this could put more upward pressure on inflation.

It's a difficult time to be a member of the MPC, with inflation running at 9% and growth starting to turn lower. Thus, if the BOE does make a surprise move today and hike rates by 50 basis points then it needs to fine tune its communication to bolster its credability. To avoid a rout in UK markets it needs to sound confident in its future policy path and it must impress on the market that its aggressive stance is important to tame inflation and thus heal the UK’s economic woes.