The Bank of England faces a huge challenge as markets demand it must now rise more than any other central bank

Image © Pound Sterling Live, again courtesy of Bloomberg TV.

The Bank of England needs to rise more than any other G10 central bank over the remainder of 2022 if it is to meet market expectations.

Following this week’s UK data releases, money market prices now show investors will be priced 154 basis points higher by the end of the year.

This is more than is required of the two typically hawkish antipodal central banks and the Federal Reserve which sets the tone.


Above: Market expectations for major central banks, image courtesy of Goldman Sachs.


This implies that three 50 basis point hikes are needed in the remaining three meetings in September, November and December.

Given that the Bank has already lifted 50 basis points in August, there is now precedent and Threadneedle Street could deliver.

The implications for the pound are significant: if it hits this target, the currency would likely remain supported, but another dovish pivot from the Bank that disappoints relative to expectations could send it lower.

A look at the following prices shows that investors have raised their expectations of the Bank through August:


Image courtesy of Goldman Sachs.


As can be seen below, the Bank of England’s expectations have risen more than those of the US:


image courtesy of Goldman Sachs.


And more than in the euro zone:


image courtesy of Goldman Sachs.


The need to raise rates further than the Bank had expected as recently as the Aug. 4 policy update comes on the back of strong labor market data this week that showed wages rose more than expected by the markets.

But it was inflation data that showed annual inflation hit 10.1% growth that fueled expectations.

The Bank itself expects inflation to peak at around 13% later in the year after the next round of energy price hikes and has pledged to fight inflation “no ifs, no buts”. in the words of Governor Bailey.

Adam Cole, senior currency strategist at RBC Capital Markets, also sees rising rate hike expectations, but using a different measure that compares to the value of the pound:


image courtesy of RBC Capital Markets.


He notes, however, that this recovery in expectations has not benefited the pound against the euro and the dollar in any significant way.

This suggests that sterling exchange rates have decoupled from rate expectations.

Of course, the pound could catch up and climb higher over the next few days and close the gap.

However, expectations of a sharp slowdown in UK economic growth are likely to keep buyers at bay for now and the gap between interest rate expectations and sterling exchange rates could remain wide. .

It should also be noted in the charts above that the downward slope of the Bank of England chart (2nd chart) is greater than all the others, therefore the Bank is likely to cut more in 2023 than its peers.

This is perhaps what matters most for forward-looking markets, and as a result, the Pound derives little benefit from the sharp rise in near-term money markets.

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