Traders should brace for a potential spike in GBP volatility in the remaining part of the week. This is because of two important events that are related to one another - release of UK CPI data for May tomorrow at 7:00 am BST and a rate decision from the Bank of England on Thursday, 12:00 pm BST.
Inflation data scheduled for release tomorrow is expected to show a small deceleration in headline CPI - from 8.7 to 8.4% YoY - and core gauge holding unchanged at 6.8% YoY. This is still much higher than the BoE inflation target of 2%. Moreover, while the headline inflation gauge began to slow, core continued to accelerate. Not to mention that the slowdown in headline UK inflation has been rather slow compared to other major economies.
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While headline UK inflation started to slow, core gauge continued to hold firm. Source: Bloomberg, XTB
Persistence of inflation is driving expectations of Bank of England continuing with rate hikes for the remainder of 2023 and ending the cycle early next year. Out of almost 40 economists polled by Bloomberg, not a single one is expecting Bank of England to decided on anything other than a 25 basis point rate hike on Thursday. However, there is a scope for a surprise as recent data from the country would justify a 50 basis point rate move. As far as market pricing is concerned, money markets see almost 100 basis points of cumulative tightening on the next 3 BoE meetings. This means that one of those decisions needs to be a 50 basis point rate hike.
Money markets see almost 100 basis points of cumulative tightening during the next 3 BoE meetings. Source: Bloomberg
Money markets currently see UK rates peaking at around 5.8% in February 2024. To put this figure into perspective, it should be said that currently the main UK rate sits at 4.50% so the market sees at least 5 more hikes over the next half a year. Those are expectations for a very hawkish BoE ahead. However, some say that pushing rates close to 6% could trigger a shallow recession in the United Kingdom and it could be a scenario that BoE wants to avoid. While BoE is likely to keep raising rates, it may at the same time attempt to cool down market expectations. Having said that, the tone and narrative of the statement from Thursday's meeting may be as important, if not more, as the size of a hike.
GBPUSD broke above the 1.2650 resistance zone last week but bulls failed to sustain the move and a pullback can be observed this week. The pair is likely to get much more volatile on Wednesday and Thursday due to UK inflation data release and Bank of England rate decision. A hawkish surprise from the Bank of England - like for example a 50 bp rate hike - could see GBP catch a bid and recover from recent losses. If BoE also sends a hawkish message regarding future meetings, bulls may target 1.30 as the next major resistance. On the other hand, failure to deliver onto markets' hawkish expectations - like for example a 25 bp rate hike and a dovish statement - could bolster downward pressure on GBP and see GBPUSD retest the aforementioned 1.2650 area but this time as a support.
Source: xStation5
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