A Preview of the Bank of England’s Interest Rate Decision

Investors expect the Bank of England to announce a tapering of its asset purchases at tomorrow’s meeting. The market positioning suggests tightening sooner than expected.

The first trading week of the month is usually filled with NFP-related news, but this week is a bit different. The Bank of England is due to present its monetary policy decision and assessment of the UK economy, and so the British pound will experience higher volatility than normal.

Like all central banks in advanced economies, the Bank of England had a swift response in the face of the COVID-19 pandemic. It lowered the official interest rate to the lower boundary and engaged in quantitative easing.

Moreover, it even studied the possibility of lowering the rate below the zero level, although it eventually refrained from doing so. At tomorrow’s meeting, many things are at stake, with some market participants expecting the central bank to announce an official date for the tapering of its asset purchases.

What to Expect from the Bank of England’s Tomorrow?

The Bank of England currently buys assets worth GBP4.4 billion on a weekly basis. A tapering of, say, GBP1.4 billion would decrease the bond-buying pace and would be bullish for the pound.

Traders should be aware of the difference between tapering and tightening. Tapering is nothing but a decrease in the bond-buying pace. In other words, the easing continues, only at a slower pace. On the other hand, tightening refers to actual contractionary policies, like a rise in the official interest rate.

At tomorrow’s meeting, the market expects the Bank of England to announce a decrease of its weekly tapering pace to GBP3 billion/week. Failure to do so means that it will taper even more in June, at the next meeting, as it has no intentions of buying bonds beyond the GBP875 billion cap.

Therefore, the pound may act with a bullish tone regardless of the outcome. If the Bank of England fails to announce a tapering tomorrow, that should create an initial bearish move, likely to be seized upon traders on the expectation of bigger tapering further down the road.

If we look at the pound’s forward rates, we see that investors expect the Bank of England’s tightening to arrive sooner rather than later. The build-up in term premia suggests that investors expect the central bank to drop its asset purchases in the near future – a bullish case for the pound.