The pound’s fortunes are being dictated by Brexit and recent optimism over a deal could lead to a more hawkish-sounding Bank of England driving the currency higher.
Market bets on further BOE policy tightening have receded in recent weeks following August’s quarter-point interest-rate increase, with the next hike not fully priced in until the end of 2019. While this could signal a non-event at Thursday’s BOE announcement for sterling and gilts, there is a risk that current market thinking could prove too dovish.
“The stronger data flow supports the BOE’s decision to tighten policy last month, and could prompt the BOE to maintain a hawkish signal at this week’s policy meeting,” said Lee Hardman, currency strategist at MUFG. “The pound has failed to reflect the stronger U.K. data flow and higher UK rates in recent months, which creates scope for catch-up strength if Brexit risks ease.”
The pound climbed this week after the European Union’s chief negotiator Michel Barnier said a deal was realistic by November, a change in tone for a market weighed down by the risk of no agreement before the UK leaves the bloc in March. That was followed by strong UK growth numbers and above-consensus wage data, though the currency has struggled to hold gains above $1.30.
“What could move the market would be if we were to see the Monetary Policy Committee suggesting that market rate expectations are a bit too dovish,” said Daniela Russell, the head of UK rates strategy at HSBC Bank Plc. “But they probably won’t want to push back too hard while Brexit uncertainty is high, and so front-end yields should stay well anchored and any sell-off is likely to be small and short-lived.”