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The BOE’s Monetary Policy Decision Day

The BOE’s Monetary Policy Decision Day

With Russia’s invasion of Ukraine hurting the economy and causing a spike in market volatility, this is the ideal time for the Bank of England to pause after raising interest rates twice in recent months to tackle rising inflation. After being asleep at the wheel for most of last year while consumer pricing pressures grew, the BOE does not have the same luxury. As a result, it finds itself in the unenviable position this week of having to stick to the hike-at-every-meeting agenda it adopted in December.

Regardless of geopolitical developments, a majority of the Monetary Policy Committee, if not all members, will likely vote on Thursday for a 25 basis-point rise, bringing the bank rate back to 0.75 percent, where it was prior to the epidemic. It’s what the central bank does in the coming months that will be more difficult, given that inflation is already at its highest level in 30 years and is expected to continue to rise.

As there will be no press conference or fresh economic predictions this week, traders will have to rely only on the decision statement to discern any changes in forward guidance. If market volatility has subsided, we believe that the MPC members will rise again in May for another interest rate hike before pausing the hiking cycle to analyze the economy’s response to the removal of monetary support.

There’s also the financial aspect to think about. On March 23, Chancellor of the Exchequer Rishi Sunak will present his Spring Statement, which might feature significant changes to government spending and taxation, as well as the Treasury’s mandate for government debt sales in the coming financial year. The February inflation rate, which is set to be released on the same day, is expected to rise to about 6% from January’s 5.5 percent annual rate. Consumer prices are set to rise even more as energy and food costs continue to rise, but job market and pay statistics remain solid. Apart from the war, there is plenty of reason for the BOE to continue tightening policy.

However, the central bank would most likely try to calm currency markets, which are pricing in a bank rate of up to 2% by the end of the year. That appears irrational, and it contradicts what most economists predict and what the bank has said. Because the market is not responding to its recommendations, it will need to reinforce the cautious stance that Deputy Governor Dave Ramsden advised.

As the conflict clouds the prospect for strong GDP growth while consumer prices continue to rise, all of the world’s major central banks are in a hard place with respect to their monetary policy decisions. At its monetary policy meeting last week, the European Central Bank emphasized the need to keep inflation under control and brought forward the date of ending the asset purchase program, and the Federal Reserve will almost definitely raise interest rates when it meets on Wednesday. The BOE should reaffirm market expectations for a third-rate hike but send a clear message that it is keeping a close eye on the geopolitical risk. 

The Fed’s Decision

The Fed increased the US interest rate for the first time yesterday since 2018 by 25 basis points which was very much in line with the market expectations. What wasn’t excepted from the Fed and which surprised the markets was their hawkish commentary about the market. The fact that the Fed believes that there could be six more interest rate hikes is an extremely hawkish stance, and not many were expecting the Fed to be this hawkish, especially not under the current circumstance when we have a war in Ukraine. The fact is that the Fed believes that they can increase the interest rates six times this year means that either they on the path of making another tremendous policy mistake to bring inflation down. Alternatively, they do not believe that the war in Ukraine imposes any considerable risk for the US economy. Nonetheless, the markets welcomed their determination yesterday, and we saw a tremendous rally in the market.

Yesterday’s stock market rally doesn’t imply that we have a bottom formed for the US equity markets, not even close. There are still substantial risks for the riskier assets, which the market players need to consider. The price action can reverse its directions reasonably quickly once the markets have fully digested the message from the Fed.