cross markets data reaction

If the Bank of England Raises Rates, How Much More Can the GBP Rally?

Wednesday, 04 July 2007 15:34:59 GMT  |  Kathy Lien, Chief Strategist

How Will The Markets React?

Interest rate announcements are always important for the foreign exchange market.  With the Bank of England, this upcoming rate decision will be market moving regardless of whether they decide to raise interest rates or not.  After having raised rates in May and then leaving them unchanged in June, the BoE is expected to lift rates from 5.50 to 5.75 percent tomorrow.  Of the 60 economists surveyed by Bloomberg, 52 or 87 percent of them are calling for an interest rate hike.  This almost unanimous view puts the “surprise” element of the event risk to the downside.  Therefore if the Bank of England leaves rates unchanged or raises rates and then issues some very neutral language in their statement, we could see a far larger move in the GBP/USD than if they do exactly what the futures curve is pricing in, which is to raises rates and remain hawkish.   According to futures traders, the BoE could bring rates up to 6 percent by the end of the year.  The recent movements in the currency, bond and stock markets indicate that British pound and Gilt traders are expecting higher rates while stock traders are not. 

Bonds – 10-Year UK Bond Yields

When it comes to interest rate decisions, the bond market is almost always right.  Since March, bond yields have been rising which means that prices have been falling.  In the middle June however yields reached a peak of 5.519 percent.  Since then, yields have fallen and are now rebounding back towards its prior high.  The asset’s inability to rally beyond the June high suggests that even though bond traders expect a quarter point rate hike tomorrow, they are not necessarily pricing in hawkish comments from the central bank.  Instead, what they are probably expecting is for the monetary policy committee to move to a “wait and see” mode, which would actually be quite likely because five out of the four members at the June meeting voted to keep rates unchanged.  A rate hike tomorrow could pass by only a slim margin.  Support in 10-year bond yields come in at 5.4 percent while resistance is 5.519 percent.



FX – GBP/USD

The currency market on the hand expects big things from the Bank of England.  Since the release of the surprisingly hawkish MPC minutes from the last monetary policy meeting, the GBP/USD has staged a very impressive rally that has seen virtually no retracements.  In fact, the move higher has been so strong that the GBP/USD hit a fresh 26 year high on Wednesday.  The GBP/USD is holding near those levels at the London close but a drop in the RSI as well as the shooting star like candlestick formation in the currency pair does suggest that we could see some profit taking before the rate decision.  Typically, in the hours before the BoE rate decision, there is a great deal of volatility in the GBP/USD.  Tomorrow should be no different since many GBP/USD bulls may be tempted to take profits before the event risk.  The price action of the GBP/USD suggests that even though traders are clearly looking for a very hawkish outcome, they are prepared to bail out of their long positions if that is not the case.  Resistance in the GBP/USD is 2.0207 while support is 2.0133.



Equities – FTSE

The UK stock market is the only market that has not priced in the imminent rate hike.  The FTSE has been rallying since the beginning of March and even though there has been a mild retracement in the beginning of June, the index is now on its way back to testing its year to date highs.  This strength stems from the fact that UK economic data has been strong while the US stock market has refused to fall.  Therefore the “surprise” element for the stock market would be a rate hike followed by hawkish comments.  6750 is resistance in the FTSE while 6500 is support. 

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