The central banks of the UK and Eurozone will be announcing interest rate decisions tomorrow.
Usually the ECB meeting steals the limelight, but this month, all eyes are on the Bank of England’s announcement. Over the past few weeks, expectations for another interest rate cut in the UK have slowly ticked higher and now, the derivatives market is pricing in a 60 percent chance that interest rates will be reduced by 25bp tomorrow (this is based upon Credit Suisse’s index of probability). The majority of economists still expect the BoE to keep rates unchanged. The major disconnect between analysts and traders is the main reason why we expect a lot of volatility after the BoE rate decision, regardless of whether the central bank chooses to lower interest rates because someone will be surprised. If the BoE leaves rates unchanged, we expect the GBP/USD to rally. If they lower rates, expect 1.95 to be broken. We believe that there is a decent chance for a rate cut since the Bank of England is traditionally a very dynamic central bank that responds quickly to changes in their economy. Recent economic data has reinforced their fears that the economy is slowing and there seems to be no respite in the foreseeable future. As a country that is heavily dependent upon financial services, the deterioration in the sector has taken a massive toll on the overall economy. Also, inflationary pressures are not as heavy in the UK, which will give the central bank the flexibility to lower rates before its too late. Both consumer confidence and leading indicators deteriorated from the prior month. Ahead of the BoE interest rate decision we have the UK trade balance due for release. Given the big event risk a few hours later, the trade numbers should not have a major impact on the British pound.