Following this heading I should probably note that the adjectives ‘big’ and ‘good’ might perhaps be more separated in our minds by the time Friday’s market close passes. A Bank of England decision scheduled for last week was postponed whilst the country was in mourning. It is now due to take place this Thursday with the financial events unfolding over the week by which the decision was delayed only adding to the stack of evidence for an oversized rate hike. Markets are therefore pricing in a 75-basis point hike on Thursday. If you believe the rest of the forward curve, rates are set to peak in around 12 months’ time at 4.5%.
Part of the backdrop demanding such a severe response from the Monetary Policy Committee is political and fiscal in nature. The details of the government’s response to rising energy costs has now given a rough figure for the extent of additional UK borrowing required to finance the new energy price measures. Of course, Truss’ plan for fiscal support ran deeper than just energy price controls. She had also pencilled in inflation sensitive tax cuts during her campaign for party leader. The details on this promise have remained elusive but likely not for much longer. On Friday the Chancellor will deliver a mini budget providing details of the tax cuts expected to cost the government up to £30bn in forgone revenue from businesses and individuals.
Both of these events present a great risk to already precarious GBP valuations. The risk boils down to how the market digests the monetary and fiscal announcements. If the market sees the mini budget as over inflationary given the extent of monetary tightening the day before then Sterling will be vulnerable. Similarly, if the monetary adjustment and forward guidance offered on Thursday is seen as insufficient to deal with the problem at hand, the Pound could be the pressure release valve. The efforts of the Bank of England to get inflation under control revolve around restoring market confidence in the central bank and its ability to deal with inflation. Whilst this will ultimately be data-driven with hindsight over how inflation evolves from its current levels, markets will make a swift assessment of the credibility of the bank this Thursday.
Discussion and Analysis by Charles Porter
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