Markets are unsure of what to expect for Thursdays Bank of England interest rate decision, leaving considerable event risk for the domestic currency.

This confusion… … is clearly visible through the past several weeks of price action, with the GBPUSD
posting volatile moves on shifting sentiment and trading within a 400+ point range.
Predictions clearly favor unchanged rates through the weeks end, with a Bloomberg
News poll showing that 42 of 50 respondents expect no hike. Recent news supports
such a hypothesis, with a Januarys rate hike coming on the heels of a hotly
contested Monetary Policy Committee vote. Bank officials approved an interest rate
increase by a narrow 5-4 margin; four no votes represent the most closely
challenged decision since 2005. Futures traders instantly bought interest rate
forwards, leaving the March UK LIBOR rate lower through the day. More recently,
however, strongly bullish domestic economic data has pushed forward rate agreements
higher leaving the March Euro Sterling contract to price in a 100% chance of a
hike through the coming two meetings. The British Pound has seen considerable
strength on the shift, but such an uptrend may be short-lived through coming trade.

Bonds – UK 10-Year Gilt Yields

UK bond yields continue to reflect expectations of higher rates through the medium
term, with the 10-year Gilt offering a near 5-percent return through todays
close. Such predictions lost traction following the release of minutes from the most
recent Monetary Policy Committee meeting, but subsequently positive data has forced
10-year debt yields to retest the psychologically significant 5.00 percent mark.
Short-term implications on price action for longer dated bonds tell us relatively
little, but the March UK LIBOR rate future shows clear expectations of a 25 basis
point rate hike in one of the two upcoming meetings. Given clear hesitation in the
vote for the recent rate increase, risks arguably remain to the downside for
predictions of higher rates through February and March. This translates into
likewise bearish risks for the British Pound, leaving recent strength in jeopardy of
retracement.

FX – GBP/USD

In the hours leading up to the Bank of Englands rate decision, FX traders have
bid the British pound across the board. However, some of this strength is coming on
the part of recent indicators. Nevertheless, the central bank’s upcoming decision
has handily guided the currency since the beginning of the week. Equipped with
convincing data from the economic coffers since the previous release and the
knowledge that the MPC has a penchant for surprises, speculation over a possible
rate hike is finding more than a little support. Central to the fundamental support
for a rate hike to match the 25-basis point boost in January is the pressure
underlying consumer spending and price gauges. Brits increased retail spending in
December by 1.1 percent following yet another drop in jobless claims and subsequent
jump in average income. More tangible for a monetary policy decision though is the
recent inflation numbers. The consumer basket reported 3.0 percent annual price
growth, while the retail price index accelerated to a staggering 4.4 percent rate of
inflation.

However, all of this data has been handicapped. For one, the most recent interest
rate hike has not been captured by most of the recent economic data. Without some
clue as to how a 5.25 percent benchmark interest rate is affecting the economy and
inflation, there is still some breathing room for the central room to defer another
firming. Whats more, the vote at the January meeting casts doubt on similar
decision for the future. At 5-4, the boost came on the slimmest of possible margins.
Looking to the market for its biased opinion, speculation highly favors a pass.
Another interesting situation to keep track of is the ECBs decision scheduled for
the same day. The divergence in policys in favor of a hawkish BoE last month has
made waves in throughout the currency market. Should conditions be exacerbated, or
otherwise rebound, the pound react in kind.

Equities – FTSE 100 Index

Overnight lending rates seem to be the furthest thing from equity traders minds.
Even though the BoE releases it official decision a day and a half from the time of
this writing, the benchmark FTSE 100 stock index has steamed ahead. In the past four
active sessions, the index has put up green bars; and has subsequently marked a new
high Tuesdays close. However, should another quarter point be tacked onto the
nations short-term lending rate, the pressure would definitely begin to build.
The benchmark indices have survived so far on a combination of impressive export
demand and burgeoning M&A activity. Should yet another surprise hike print, the
resulting rally in the British pound, and additional burden to borrowers would
quickly diminish prospects for the future. On the other hand, the recent strength
may be an impromptu statement by the investing community that they see little chance
of a February rate hike. While conditions do support such a pass, stocks will likely
consolidate in the hours preceding the meeting’s conclusion — just in case.

Regards,

John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com

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