Markets Look to February for Next Turning Point in BOE Rate Bets
(Bloomberg) -- With traders wagering that a Bank of England rate hike in December is nearly a done deal, they’re turning their attention to February.
The big question for traders is whether the Monetary Policy Committee raises borrowing costs to 0.5% by then -- the threshold after which policy makers may let gilts that mature in its 875-billion pound ($1.2 trillion) asset-purchase program roll out of the portfolio without being replaced.
It could also determine whether the central bank reinvests a 28-billion-pound gilt maturing in March. Choosing not to would help the BOE tighten policy and contain consumer prices running at the fastest pace in nearly a decade.
Currently, money markets are betting the key rate will be about nine basis points short of hitting that level.
Raising rates to 0.5% by February “would allow the MPC to remain in ‘tightening mode’,” Royal Bank of Canada strategists led by Peter Schaffrik wrote in a note.
Traders have almost fully priced a 15-basis-point rate hike at the BOE’s Dec. 16 meeting. Yet Huw Pill, the central bank’s chief economist, cast doubt over that prospect and noted that the decision would be “finely balanced” amid bumps in the economy.
BOE staff estimated that 60 billion of asset purchases in August 2016 equated to a policy cut of about 50 basis points. While the BOE has said reducing the balance sheet may have a smaller impact, stopping the reinvestment of maturing debt, known as quantitative tightening, would still allow officials to somewhat restrict policy while shielding most short-term borrowers from higher borrowing rates.
But the window to act is small. Schaffrik and his colleagues noted that after the March bond maturity, there are only a further 9.1 billion pounds of bonds maturing before July 2023, which would make quantitative tightening a less effective policy tool. That could leave higher interest rates as the only alternative route to tighter monetary policy.
For many investors, BOE credibility took a hit earlier this month, when policy makers wrong-footed markets by keeping interest rates steady at a record low 0.1%. This was after Governor Andrew Bailey and his colleagues warned on the need to act to curb surging inflation.
Re-emerging Brexit risks could further cloud the picture for the BOE. With the government in London threatening to invoke Article 16 of the Northern Ireland protocol, which governs trade in the region, economists warn that retaliatory measures from Brussels could hit exports and investments and deliver a further blow to the pound.
If that happens, the BOE will refrain from tightening policy in December, according to Andreas Steno Larsen, global chief strategist at Nordea Bank Abp.
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