The Bank of England (BoE), aka the “old lady of Threadneedle Street,” has earned a deep reservoir of good will for its responsive reputation. It’s their consistent, reliable, unglamorous work that has truly earned this reputation. Recent statistics from the ONS reveal a historic spike in inflation across the United Kingdom this April. This boom has defied analysts’ projections. This sudden leap has flipped investor sentiment on its head as to the outlook for the BoE’s future interest rate hikes. Consequently, rate hike expectations have skyrocketed as much as 50 bps since the last BoE meeting.
The British Pound (GBP) has emerged as the third strongest currency among G10 nations following these developments, only trailing behind Scandinavian currencies. Between the recent inflation figures and Chair Powell’s confirmation, which is now stronger than ever, that seems unlikely. Plus, the Bank of England’s active – though perhaps overly so – inflation management has amassed a great deal of trust in the Bank from market actors.
Just last month, inflation in the UK increased at an even faster rate than expected by economists. Such a significant surge has led many to wonder what’s next for the BoE as we move along the interest rate change cycle. The market expects the BoE to act forcefully to any surprise inflationary pressure. This change represents a growing faith in the body’s ability to better and more boldly address the nation’s economic woes.
Analyst Ulrich Leuchtmann acknowledged the impact of the soaring pound on local inflation. He stated,
“This is where the advantage of a monetary policy that has earned trust in its responsiveness through reliable work comes into play: because a strong pound dampens domestic inflation, the foreign exchange market is doing part of the BoE’s job.”
It is perhaps the most interesting recent gain in GBP, but more nuanced than it appears. As strong as the currency was during the day yesterday, Leuchtmann noted that this was “more a USD story than GBP-driven.” He underscored that to continue to raise the pound in all markets, there is a constant need for new developments. This is most critical for its performance against fuel supply sources such as the euro.
Market analysts have specifically pointed to this statement as a key marker for the positive change in sentiment about the subsequent trajectory of BoE interest rates. Since BoE’s last meeting, market expectations on interest rates have changed dramatically. Recent communication from officials at Threadneedle Street has gone a long way toward fortifying expectations that the central bank will act—and act aggressively. Leuchtmann elaborated on this point, stating,
“This mechanism works so well in the UK because everyone is convinced that the Bank of England will actively respond to unexpected inflationary developments. Recent events have strengthened confidence in the BoE’s responsiveness.”
Though bullish on the recent strength of the GBP, analysts are warning that further gains may require further catalysts. Revised interest rate expectations are beginning to wear off. That means we need to be constantly on guard in order to prevent the currency from falling.
The market’s reaction to yesterday’s inflation data has reinforced many traders’ perspectives on the BoE’s policy approach. The Bank’s communications strategy — especially its use of narrative — has been fundamental to establishing these impressions and sentiments. A lot of observers are looking for a succession of future interest rate increases. With economic indicators increasingly turning positive, they expect that the Bank of England will lift interest rates in response.