Bank of England set to hold interest rate steady as war revives inflation fears

The Bank of England (BoE) is on track to leave the benchmark Bank Rate unchanged at 3.75% for the second meeting in a row on Thursday, as the macro context has completely shifted in the past three weeks. 

Prior to the Iran war, markets were leaning toward a near-term rate cut, but the surge in Oil prices has changed expectations and currently, investors broadly expect the BoE to take a wait-and-see approach. 

The Monetary Policy Committee (MPC) policymakers are seen voting 7-2 to keep rates on hold, following the conclusion of the March monetary policy meeting. In the past meeting, the committee also decided to keep rates on hold after a tight 5-4 vote split.

Even though it’s not a “Super Thursday” – there won’t be any Monetary Policy Report (MPR) or a press conference from Governor Andrew Bailey – the Pound Sterling (GBP) is primed for a big reaction to the United Kingdom (UK) central bank’s policy announcements at 12:00 GMT.

What to expect from the Bank of England policy announcements?

As the war in the Middle East rages on, the BoE is caught in a dilemma over whether to look through the short-term energy-driven inflation shock or act against it at the expense of the fragile economy.

Data from the Office for National Statistics (ONS) show that the UK economy stagnated in January, despite expectations for a 0.2% growth in the reported period.

Meanwhile, inflation, as measured by the change in the Consumer Price Index (CPI), cooled markedly in January to 3% on an annual basis from December’s 3.4%, aligning with the market estimates.

Core inflation, excluding energy, food, alcohol, and tobacco, came in at 3.1% in January, down from 3.2% in December.

Cooling inflation led markets to quickly ramp up bets for the BoE to cut its benchmark interest rate at its March meeting. However, this data set was published before the Middle East war, which prompted markets to reprice their expectations for the central bank to extend the pause on rate cuts.

With a no-rate change decision widely expected, the focus will be on the MPC voting composition, which could turn more hawkish than February’s 5-4 hold and the expected 7-2 split.

Additionally, the language in the Monetary Policy Statement (MPS) and the Minutes of the meeting will be dissected to gauge the timing of the next rate cut amid geopolitical uncertainty.

“We think the case for BoE to hike rates is weaker, partly given it has cut rates less aggressively so far in this cycle, and at least some MPC members likely still see rates as restrictive,” Standard Chartered analysts said in a research note.

“We still see more easing from the BoE (we forecast a terminal rate of 3.00%), but the timing of those cuts are highly uncertain and under review – while a near-term cessation of hostilities and a retrenchment in energy prices could allow our current schedule of cuts (once per quarter from Q2) to play out, there are increasing risks that a prolonged energy price spike could push the next cut back into H2 or 2027,” they added..

How will the BoE interest rate decision impact GBP/USD?

The GBP has sustained its recovery from three-month lows of 1.3219 against the US Dollar (USD) heading into the BoE’s monetary policy decision.

If the BoE’s statement strikes a cautious tone while the MPC vote split comes in hawkish in the face of potential upside risks to inflation, the Pound Sterling could see the extension of the latest turnaround. In such a case, GBP/USD could stretch further toward the 1.3500 level.

On the other hand, the GBP could fall back toward multi-month lows below 1.3250 against the USD should the central bank prioritize economic recovery over a temporary inflation shock. Markets would perceive this as a dovish call, reviving bets for a rate cut later this year.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for GBP/USD: 

“The near-term bias is mildly bearish as spot holds beneath the 21-day, 50-day and 100-day Simple Moving Averages (SMAs), which all sit in a descending stack under the 200-day SMA and cap recovery attempts. The 14-day Relative Strength Index (RSI) at 43 stays below the 50 line, indicating persistent but not extreme selling momentum that keeps rallies vulnerable.”

“Initial resistance emerges at the 21-day SMA near 1.3415, followed by the 50-day SMA around 1.3510 and the late-January high zone near 1.3695. On the downside, immediate support stands at 1.3219, the three-month low seen last Friday, ahead of the 1.3150 (psychological level),” Dhwani adds.