U.K. Markets Vulnerable to Any BOE Hawkish Surprise This Week

(Bloomberg) -- Investors in the U.K. are underpricing the prospect of the Bank of England sounding more hawkish this week.

While the BOE is seen holding rates at its policy decision Thursday, low unemployment and the U.K.’s Brexit extension may prompt one or more officials to vote for an increase, according to some strategists. With money markets not pricing in any hike until 2021, such a move could boost the pound and further pressure benchmark gilts as they head for a monthly loss.

U.K. Markets Vulnerable to Any BOE Hawkish Surprise This Week

“There’s a prospect of a hawkish tone -- they will obviously still be focused on the Brexit uncertainty and political risks, but they won’t ignore the strength of labor-market and retail-sales data,” said John Wraith, head of U.K. rates at UBS Group AG. “They won’t convince the market a hike is imminent, but I think they would like more balanced two-way risk priced into the front end.”

Brexit Extension Leaves Rates Market Trapped in Limbo for Now

Both U.K. government bonds and the pound have been trapped in a range by the lack of progress on Brexit in recent months, even after Britain’s departure from the European Union was delayed until October. As Prime Minister Theresa May is unlikely to put her withdrawal deal to a vote in Parliament next week due to insufficient support, it could be down to the central bank to provide impetus to a market that’s grown weary of the political deadlock.

The pound traded at $1.2930 as of 4:30 p.m. London time Friday, close to a two-month low touched Thursday. The yield on 10-year gilts has risen about 14 basis points from 1 percent at the end of March.

With the Brexit reckoning postponed, there is a chance that the BOE’s Monetary Policy Committee will raise its key interest rate from 0.75 percent in August, according to Nomura International Plc. Six out of 24 economists in a Bloomberg survey expect at least one MPC member will call for an immediate tightening when the central bank announces its decision at noon Thursday in London, when it also releases its latest economic projections.

“With U.K. data surprises on the rise, inflation expected to jump higher thanks to energy costs, and a communication of one hike per year, that would mean August is still a possibility despite November remaining our view for the most likely timing,” said Jordan Rochester, an analyst at Nomura. “Either way, both are underpriced and any votes for a hike at this meeting by MPC members could support the pound.”

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