Above: File image of Megan Greene. Image © Informa Connect Global Finance.
The odds of a July rate hike by the Bank of England are underappreciated by the market, which offers summer support for the British pound in the coming weeks.
That's according to economists we follow who say that although June is too soon for the Bank to raise interest rates, by July the need for an 'insurance' hike will be hard for Monetary Policy Committee (MPC) members to avoid.
That should underpin interest rate expectations and, in turn, support gilt yields and the pound through the summer months.
Central to the case for a July hike is Megan Greene, an MPC member who looks ready to join Chief Economist Huw Pill in arguing for a rate hike. Catherine Mann will also likely opt for a hike.
Greene said in a speech this week: "I believe a more proactive approach may be needed to lean against inflation when an economy has been hit by successive supply shocks."
"We continue to see grounds for the BoE hiking and suspect that Megan Greene’s views will grow in popularity the longer the Strait of Hormuz remains closed," says a note from MUFG Bank, released midweek.
Above: Evolution of money market expectations for Bank Rate since March.
The Bank of England was expected to lower interest rates on a number of occasions this year, but the Iran war sent oil and gas prices higher, presenting the UK economy with another inflationary shock.
The shift in interest rate path was felt on the currency market, with the pound to euro exchange rate rising from just below 1.14 to reach a high at 1.16 during March. The pair has since kept in touch with the 1.15-1.16 range as policy-relevant bond yields have yet to relinquish their gains.
Above: Interest rate expectations feed into higher two-year bond yields (lower panel), which supports GBP/EUR (top panel).
Lowering interest rates could have fuelled the inflation shock caused by the war, but the Bank has said it wants to see the impact of the war on other elements of the inflation basket before rushing into a hike.
And, Governor Andrew Bailey has argued recently that the rise in UK rate expectations has already done some of its work.
Indeed, mortgage rates are about a per cent higher since the war, which should constrain financial conditions.
"A June rate rise now looks unlikely amid a fall in oil prices and weaker economic data. Yet a hike in July is possible if energy flows through the Strait of Hormuz don’t materially - and durably - improve over the next 10 weeks," says James Smith, Developed Markets Economist at ING.
MUFG says a hike "certainly seems unlikely in June based on Bailey’s comments but if uncertainty persists much longer it appears likely that the MPC will vote to hike on 30th July."
"BoE members Megan Greene and potentially Catherine Mann look likely to join Huw Pill in advocating for higher interest rates, even if Governor Andrew Bailey appears much less convinced," says ING's Smith.
For the pound, a July hike could offer support as money market pricing shows investors are only priced for the move at 50-50, "so there is scope for market yields to move higher, especially at the front-end," says MUFG.
"All else equal that should provide support for the pound, more against the euro where monetary policy pricing looks more realistic than potentially in the US," adds the bank's FX strategy team.
However, Georgette Boele, Senior FX Strategist at ABN AMRO, says in a note released midweek that she has cut the pound's forecast profile against the euro and dollar as the Bank of England is expected to keep interest rates unchanged this year.
"After Governor Bailey’s dovish speech last Friday in Reykjavik, we changed our Bank of England base case to a prolonged pause. Previously, we expected a rate hike over the summer," says ABN AMRO in a note out Wednesday.
In his speech, the Governor said the Bank's decision to take rate cuts off the table at recent meetings had already had the effect of pushing back against inflation: "we have already tightened policy considerably in response to the shock relative to what had been expected by markets. And that is already affecting the economy."
In response, "we now expect sterling to be weaker," says Boele. "The main reason is our change in the Bank of England policy outlook. Markets are currently pricing in around 50 basis points of rate hikes this year, while our view is more dovish than that consensus. As a result, the absence of rate hikes assumed in our updated BoE view is likely to weigh on sterling this year."
Additional potential headwinds for sterling remain the familiar political and associated fiscal uncertainties with Andy Burnham the favourite to win the Makerfield by-election in two weeks and challenge Keir Starmer for the top job.
That "could still get in the way of any rate driven pound strength," says MUFG.