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"One of the most exciting BoE meetings in recent months is likely ahead of us" - Commerzbank.
The Bank of England faces a critical policy crossroads as it weighs cutting interest rates further despite persistent core inflation and a weakening UK economy.
Today’s decision, and the tone of its accompanying Monetary Policy Report, could determine whether the Pound extends its recent losses or finds room for recovery.
"The pound has moved largely sideways, underperforming against a slightly stronger euro but outperforming against a weak US dollar. However, this masks the underlying problems. Core inflation has been stubbornly high for over two years, making interest rate cuts difficult. Conversely, the real economy is weakening, which suggests that interest rate cuts are warranted," says Michael Pfister, FX Analyst at Commerzbank.
This tension makes August's policy decision and Monetary Policy Report, "one of the most exciting meetings in recent months," he adds.
Does the Bank of England lean towards more support for the economy via further rate cuts, potentially taking Bank Rate below 3.5% early next year? Or does it do what is needed to validate current expectations that show two more cuts are likely over the next two quarters?
If the former, then the Pound's selloff can extend, if the latter, then a recovery is possible.
Joseph Capurso, FX strategist at Commonwealth Bank, thinks there is reason to expect a cautious response that could ultimately benefit Sterling.
"GBP/USD is trading at its 100-day moving average of 1.3355 ahead of today’s Bank of England (BoE) interest rate decision. The BoE is widely expected to cut the bank rate by 25bps to 4.0%. Since the BoE last met in mid‑June, the UK economy has been sluggish. However, UK core inflation remains too high. GBP could lift above weak resistance at 1.3390 if the BoE cuts but signals concern about continued high inflation," says Capurso.
Although the economy isn't firing on all cylinders, it's doing OK: the July services PMI was revised higher, suggesting that firms reporting late in the month are more optimistic. The headline PMI in July was raised to 51.5, leaving it above the 50.5 average for the first half of the year.
"Growth is improving from a weak spot in the spring as uncertainty falls back," says Rob Wood, Chief UK Economist at Pantheon Macroeconomics.
Above: GBP/EUR with Monday's Week Ahead Forecast annotations, which shows price action is evolving as expected.
Such an assessment, if shared by the Bank of England, would encourage a more restrained policy guidance that could support the Pound on the day.
However, Kirstine Kundby-Nielsen at Danske Bank thinks the Pound will continue to struggle, even if the Bank sticks to its guns.
"We expect a muted market reaction as we expect the BoE to refrain from altering its current guidance. More broadly, we stay negative on GBP. An investment environment characterised by elevated uncertainty and a positive correlation to a USD negative environment, in our view, favours a weaker GBP," she says.
Kundby-Nielsen adds that tentative signs of a weaker growth outlook for the UK economy will act as a headwind for GBP. "We therefore expect EUR/GBP to move higher towards 0.89 on a 6–12-month horizon." (This gives a GBP/EUR point target of 1.1235).
A strategy note from TD Securities says initial market focus will be on the vote split, where we will get a sense of how thinking on the Monetary Policy Committee (MPC) is evolving.
"Any unexpected dovish lean on the back of recent softness in data can weigh on the GBP," says the note.
Above: GBP/USD at daily intervals with Monday's Week Ahead Forecast annotations, confirming price action has evolved as expected.
Two members of the MPC could vote for a 50 basis point cut today, which would signal strong resistance to any future decision to hold Bank Rate and end the cutting cycle, implying sub-3.5% is possible. However, other members could opt for rates to be left unchanged.
The vote share should show the underlying tensions on the MPC. This is not necessarily a bad thing, but for the Pound any decisive swing in favour of cuts could weigh. Likewise, a lack of 50bp votes could bolster the currency.
According to TD Securities, the Pound could fall by as much as 0.65% on a particularly 'dovish' scenario where "the press release shows intensification of the language that suggests more slack building in the economy. There was already a shift from the May to June meetings regarding the labour market and economic growth. The dovish risk, therefore, is that this component of the statement becomes even more pointed."
"We expect a 25-basis point cut to 4.00% at today's meeting, but it is not impossible that the BoE opens up for faster rate cuts in the future," says Amanda Sundström, FX Strategist at SEB.
The decision is at 12PM, with a press conference due to follow at the bottom of the hour. Governor Andrew Bailey's tone will also be important in this regard.