There is no clarity as to whether the Bank of England will raise interest rates. While political factors would preempt a rate hike to ward off the notion of a weak economy, with policy makers may allude to a sense of political and financial rectitude in an otherwise tumultuous environment; fundamentals, however, do not support this approach. For example, the economy has witnessed a more pronounced slowdown and the GDP growth expectations have been revised downwards from the earlier anticipated increase of 0.3%. This has occurred due to a flailing consumer spending, because of reduced disposable income function brought about by an inadequate real wage growth rate. Surprisingly, though, the Purchasing Managers index for the economy as a whole has registered an improvement during May. In addition, May activity saw a sharp and accelerated increase in permanent staff placements across UK, with the rate of expansion being the fastest over the last 25 months. High inflation does set up the precedent for a rate hike, but BoE regards the Brexit uncertainty as the overriding variable in setting its policy. Thus, some view that strongly capped central bank rate expectations, yet political uncertainty, place the Pound Sterling to a downside risk. Economists do foresee, UK’s inflation moderating to the 2% mark, but feel that the assumption of a smooth Brexit, particularly in wake of June’s general election, is a bit farfetched.
However, the move by Bank of England’s Monetary Policy Committee (MPC) in which 3 out of eight participants were of the view of an interest rate hike should be instituted took the market by surprise. Kristin Forbes, joined by Michael Saunders and Ian McCafferty stipulate for an increase to the cost of borrowing. This surprising news did allow the sterling to sharply appreciate to $1.2768 but the FTSE 100 and 250 reacted negatively losing 0.74% and 2.11% respectively. Thus, the 5-3 split means that odds in favor of a rate hike are gaining some momentum, with the Bank showing the highest propensity for a rate hike decision since 2007. The overriding factor obviously remains the inflation rate, which by Office of National Statistics hit 2.9% in May, higher than the Bank of England’s forecast for the month. The MPC has contended that the recent rise of labor market robustness would necessitate a quicker rise than expected given that they forecast an above 3% inflation rate as early as autumn. Richard Kelly of TD securities has alluded that while mixed maco-economic landscape and the prevalent political uncertainty, there are “silver linings, however, as the Brexit process now appears more open to interpretation,” which would ultimately reduce headwinds for the sterling. While only 3 allusions to uncertainty emanating out of the June election in the MPC meeting, it seem that it would be impulsive not to wait and see how the current political uncertainty unravels and subsequently how the economy ultimately contends with Brexit negotiations, even though for now the prospects for smooth negotiations seemingly unlikely. RBC Capital, a premier global investment bank, rationalizes the current scenario for a falling parity to 1.19 against the greenback, during the third quarter of 2017, which may continue declining to 1.15 as the year ends, but does witness a rebound during 2018. While, they do not specify any target against the Euro, but with some hefty consolidation, the parity could fall down to as low as 1.1299 in the near future.