UK Interest Rate Decision Preview: BoE hike hangs in the balance as inflation cools

• The UK central bank is on track for another 25 bps hike on Thursday, lifting interest rate to 5.50%.
• The Bank of England could signal the end of its tightening cycle as economic woes mount.
• Pound Sterling set to rock after surprise fall in UK inflation raises odds of a BoE rate hike pause.  

The Bank of England (BoE) is set for the fifteenth consecutive interest rate hike since December 2021 on Thursday. The Pound Sterling (GBP) is poised for a big reaction even though it is not a ‘Super Thursday’, as it could probably be the final lift-off for one of the United Kingdom’s (UK) greatest tightening cycles in the last century.

However, markets have recently lowered expectations of a rate increase after UK inflation in August came in softer than expected.

Bank of England Interest Rate Decision: What to know in markets on Thursday, September 21

• GBP/USD remains vulnerable near five-month lows of 1.2304, as the US Dollar (USD) clinches fresh a six-month high. 
• The US Dollar and the US Treasury bond yields continue to soar on the hawkish US Federal Reserve (Fed) rate hike pause.
• The Summary of Economic Projections (SEP), the so-called ‘Dot Plot’ chart, showed that the “Fed projections imply one more 25 basis points (bps) rate hike this year and 50 bps of rate cuts in 2024, versus 100 bps of 2024 cuts in June projections.”
• US S&P 500 futures drop amid risk-aversion on the Fed’s ‘high for longer’ interest rate view. 
• The BoE policy guidance will hold the key for a clear directional impetus for the GBP/USD pair while the Jobless Claims and Existing Home Sales data from the United States will also entertain Cable traders.

When will the BoE announce its interest rate decision and how could it affect GBP/USD?

The Bank of England is widely expected to raise the benchmark interest rate, the Bank Rate, by 25 basis points (bps) from 5.25% to 5.50% at 11:00 GMT, taking borrowing costs to the highest level since 2007.

The big question is whether it will be the last hurrah for the BoE hawks. The UK central bank could take the lead from the European Central Bank (ECB) and deliver a dovish hike by signaling the end of its rate hike cycle amid increasing risks of stagflation.

In the second quarter, the UK economy defied expectations of stagnation, expanding by 0.2% in the second quarter. However, economists say that the growth outlook appeared grim, as the impact of higher rates had still not fully fed through.

Meanwhile, the Unemployment Rate climbed to 4.3% in the quarter through July from the 4.2% seen during the three months to June. The economy saw an employment loss of 207K in July, having shredded 66K jobs in June. Average Earnings excluding bonuses rose 7.8% 3M YoY in July as expected but at a joint-record pace.

Against the backdrop of a slowing economy and loosening labor market conditions, the BoE could be well-positioned to hint at a pause after the expected rate hike. Goldman Sachs and Citigroup expect Thursday's decision to be the BoE's last rate hike.

Governor Andrew Bailey said earlier this month that the BoE was "much nearer" to ending its tightening cycle. On the other hand, Catherine Mann, a member of the BoE Monetary Policy Committee (MPC), said last week, “I would rather err on the side of over-tightening,” adding that underestimating the persistence of inflation will lead to an overshoot. 

However, the unexpected fall in the UK inflation cast clouds on the BoE’s rate hike plan on Thursday. Bailey and his colleagues could opt for a pause, as services inflation points to easing inflationary pressures. 

The Office for National Statistics (ONS) said on Wednesday that the UK annual Consumer Price Index (CPI) edged 6.7% higher in August, cooling off from a 6.8% rise in July. The market consensus was for a 7.1% increase. 

The Services CPI rose 6.8% YoY vs. July’s 7.4% surge. The ONS said, “the largest downward contributions to CPI rates came from food and accommodation services.”

Markets are pricing a 50% probability of a 25 bps rate increase by the Bank of England, down sharply from an 80% chance seen before the UK inflation data.

Analysts at TD Securities (TDS) noted: “Upside surprises to wage data are enough to justify a 25bps hike, but Wednesday's downside shock to August inflation and worries about tepid GDP growth and a rapidly rising unemployment rate lead the MPC to soften forward guidance and votes skew toward a hold, effectively signaling an end to the hiking cycle.”

If the Bank of England delivers a dovish message alongside a 25 bps rate hike or decides to put brakes on its tightening cycle, GBP/USD is likely to see a fresh downswing toward the 1.2250 psychological level. In case the Bank hints at a possibility of one more rate hike by the turn of the year, the Pound Sterling could stage a decent recovery toward the 1.2500 threshold.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the major and explains: “Having consolidated the downside break below the critical 200-Daily Moving Average (DMA) at 1.2433 so far this week, GBP/USD is extending the downtrend even as the 14-day Relative Strength Index (RSI) has entered the oversold territory, suggesting that the pair risks a correction from the multi-month trough.”

Dhwani also outlines important technical levels to trade the GBP/USD pair: “On the upside, recapturing the 200 DMA support-turned-resistance is critical to initiating any meaningful recovery toward the 1.2500 figure. Further up, the descending 21 DMA at 1.2520 will challenge Pound Sterling buyers. Conversely, the immediate support aligns at the April low of 1.2275, below which a sell-off toward the 1.2200 threshold cannot be ruled out.”