(Bloomberg) --
The devil is in the detail for pound watchers at HSBC Holdings Plc going into Thursday’s Bank of England decision.
Economists expect the BOE to hike its key rate to 0.50%, at the same time triggering passive balance-sheet reduction. While the increase is almost fully priced in by money markets, limiting the scope for sterling upside, the central bank could still deliver a hawkish surprise through its inflation forecasts and any discussion of active quantitative tightening, according to Dominic Bunning, HSBC’s head of European currency research.
“A key reason for our long-held skepticism on GBP has been the flatness of the rates curve,” he said in a note. “If the terminal rate were to be adjusted much higher, due to either of the above forces, it would provide more ammunition for rate hikes and would create a less negative backdrop for sterling.”
The pound is trading around its strongest level in almost two years against the euro, buoyed by expectations the BOE’s tightening cycle will far outpace the European Central Bank’s process. Money markets are betting on close to 125 basis points of hikes this year in the U.K., compared with around 25 basis points in the eurozone.
The pound rallied to 83.05 pence per euro on Monday before paring gains, with Prime Minister Boris Johnson due to make a statement to Parliament later.
The latest BOE forecasts had inflation receding to its 2% target in 2024. If the new projections do not show a return to target or a slower return, it may flag that officials would like to see a more aggressive hiking cycle priced in that would support the pound, according to Bunning.
A signal that active gilt sales are on the horizon, meanwhile, could push U.K. yields and sterling higher, he said. The BOE has said it will consider actively selling its bond holdings once the policy rate hits 1%, which is priced in for June. It’s uncertain whether the BOE will start active sales straight away at that level or wait. In the August policy report, officials said their preference is to use the Bank Rate as the “active instrument in most circumstances.”
©2022 Bloomberg L.P.