There is rising market consensus in the City of London that the Bank of England (BoE) is poised to raise interest rates at its next Monetary Policy Committee (MPC) meeting on 2 August, and one commentator says it'll offer a short-lived window of opportunity for the pound to recover.
Richard Falkenhäll, Senior FX Strategist at Nordic Bank SEB, says he agrees with market consensus over the BoE delivering a 25bps rate hike to 0.75%. "Traditionally higher interest rates tend to strengthen the currency. For example, last year when the BoE raised the bank rate by 25bps to 0.50%, it had a positive impact on the GBP, which strengthened by almost 4% against other G10 currencies after the 14 September 2017 meeting, when new guidance suggested increased probability for a rate hike in November."
In recent years, a few other central banks, like the US Federal Reserve and the Canadian central bank (BoC), have tightened policy several times.
These actions were also combined with appreciating currencies, although most of it happened prior to the rate decisions while they traded roughly sideways afterwards.
Falkenhäll notes the GBP has so far not strengthened at all against other currencies. "In fact, it has depreciated since the last BoE meeting in June, while the probability of a hike in August has increased significantly from 36% the day before the June meeting to 85% (this week ahead of the 2 August meeting), according to market pricing.
"One obvious reason is of course the political turbulence and the Brexit risk premium. However, most of the appreciation in 2017 occurred in the last nine days ahead of the rate decision. Experience suggests there should be some room for a temporary recovery of GBP in coming days, although it is unlikely to last after the decision."
Given the mess in British government and the weak support of Prime Minster Theresa May’s Brexit plan, there is little to suggest a positive pre-BoE reaction in the GBP will last beyond the day of the rate announcement, Falkenhäll notes.
"Moreover, there is still a risk that market expectations and our forecast turn out to be wrong and the BoE leaves policy unchanged, which probably would be the most reasonable decision."
