Bank of England set to stand pat on interest rate as inflation steadies

The Bank of England (BoE) is on track to leave the benchmark Bank Rate unchanged at 3.75% for the fourth consecutive time on Thursday, as the US-Iran peace deal and the softer-than-expected consumer inflation figures seen earlier in the week have eased pressures to tighten its monetary policy. 

UK economy is giving worrying signs of weakening at the outset of the second quarter, and Consumer Prices Index (CPI) figures have shown inflationary pressures remained somewhat contained in May. With Oil prices in decline and a US-Iran peace deal at the table, the BoE seems unlikely to hike interest rates on Thursday and probably not in the rest of the year either.

It will not be a “Super Thursday,” and therefore, Governor Andrew Bailey will not speak after the decision. Markets will look through the minutes of the bank and analyze changes in the vote split to try to assess the bank’s forward path.

What to expect from the Bank of England policy announcements?

Recent UK data and the progress on the US-Iran peace process have significantly changed the scenario for the Bank of England, and although the bank is unlikely to alter its “wait-and-see” stance, these new circumstances might prompt BoE policymakers to adopt a more dovish stance.

Oil prices have dropped sharply from recent highs: Brent Oil is about 30% below the level it was at the previous BoE meeting. The US and Iran have advanced towards a peace deal that might lead to resuming toll-free shipping through the Strait of Hormuz, which would contribute to easing energy prices further.

In the UK, Consumer Price Index figures released on Wednesday delivered a positive surprise. Yearly inflation remained steady at 2.8%, significantly below the 3.3% peak reached in March, with monthly inflation easing to 0.2% from 0.7% in the previous month and core inflation growing below expectations. May’s inflation figures are below the Bank of England’s February projections, easing pressure on the bank to hike interest rates in the coming months.

Beyond that, the UK economy is giving signs of exhaustion. Gross Domestic Product (GDP) shrank 0.1% in April, following a 0.3% growth in March and 0.4% in February, and Industrial Production stalled after a 0.2% contraction in the previous month. In this context, the BoE risks tipping the economy into a long-lasting recession by tightening borrowing costs.

The bank voted in April to keep interest rates on hold by 8 votes against 1, with the bank’s Chief Economist, Huw Pill, calling for a rate hike. Investors will be eager to know whether Pill has changed his mind in the new scenario, and, possibly, for any potential voices bringing rate cuts back to the table.

In conclusion, recent developments have cemented market expectations that the BoE will stand pat on Thursday, shifting the focus to the vote split to assess whether the soft inflation and economic growth data have prompted committee members to ditch hopes of interest rate hikes.

Analysts at Deutsche Bank agree that recent developments have provided some leeway for the BoE to maintain its policy unchanged: “The sting from the Iran conflict looks less than markets initially assumed. The peak in CPI could end up well below what we saw last year. This could give the BoE some pause for thought. Indeed, it could buy the MPC more time to assess the risks around so-called second round effects.”

How will the BoE interest rate decision impact GBP/USD?

The British Pound (GBP) has been trading sideways around 1.3400 against the US Dollar (USD) this week, after picking up from two-month lows near 1.3300. Reports of progress in the US-Iran peace talks have supported a moderate Pound recovery, as risk appetite undermined demand for the safe-haven USD. 

The pair, however, remains halfway through the monthly trading range, with upside attempts limited below the 1.3500 area.

The risk from the BoE’s monetary policy decision is skewed to the downside, as macroeconomic data has paved the way for the bank to leave interest rates unchanged in the near-term. With this in mind, investors will be looking for hints of a dovish turn, which might increase negative pressure on the Pound.

Guillermo Alcalá, FX Analyst at FXStreet, sees the GBP/USD likely to drift lower towards the 1.3300 area if the BoE delivers a “dovish hold”: “The pair lost momentum after the release of the UK CPI data and might extend its reversal if the BoE turns dovish. Immediate support at the 1.3380-1.3390 area might give way, but it might require additional impulse to breach the key 1.3300 area.”

Upside attempts remain limited for now, but Alcalá warns that the confirmation of a peace deal in the Middle East might send the GBP surging: “Pound buyers are lacking incentives right now, but we should not forget that the reaction to the US-Iran deal has been tame so far. If the peace agreement is confirmed and the Strait of Hormuz reopens, risk appetite might boost the Pound to 1.3500 and beyond.”