Monday rate hike an option for BoE to back pound - Capital Economics

(Alliance News) - The Bank of England needs to "step in" to rescue the pound from its historic lows, analysts at Capital Economics said on Monday, after sterling crashed to below the USD1.04 mark.

One of the options Threadneedle Street may turn to is an interest rate hike "as soon as this morning". It would not be a small hike either.

Paul Dales, an analyst at Capital Economics, said an option the BoE has is to enact a 100 or 150 basis point hike. That would take the key bank rate as high as 3.75%.

"Perhaps as soon as this morning," Dales said.

Last week, the BoE enacted its second-successive 50 basis point hike, lifting rates to 2.25%. The half-point lift was the joint-chunkiest since 1995. A rise of a full percentage point or more would tower over that, however.

"By bringing forward a lot of the policy tightening that might needed to have happened anyway, the Bank would demonstrate in no uncertain terms that whatever the government does it will ensure that inflation returns to 2%. This would go a long way to easing the crisis," Dales commented.

Sterling fell to an intraday low of USD1.0349 earlier Monday, its worst ever level against the dollar. It regained poise as the morning progressed to fetch USD1.0786 at around 1020 BST.

Sterling has struggled since UK Chancellor Kwasi Kwarteng announced a series of tax cuts and spending plans in a 'fiscal event' on Friday. The UK chancellor over the weekend hinted more tax cuts would follow those he announced last week.

Kwarteng, who has launched a review of all tax rates ahead of a formal budget, is reportedly considering abolishing a charge for parents who earn more than GBP50,000 and claim child benefit, increasing the annual allowances on pension pots, and a tax break for people who stay at home to care for children or loved ones.

A hefty rate hike this morning is one of two pound-boosting options which Dales outlined.

Another option would be for BoE Governor Andrew Bailey to emphasise the central bank's aim to return the inflation rate to the 2% target, while also "providing a clear signal" that an aggressive rate hike is coming.

"If this were coordinated with a message from the government that it is committed to long-term fiscal discipline and will bring forward plans to spell out how it intends to keep the public debt position stable following last week's fiscal splurge, then it could relieve some downward pressure on the pound," Dales added.

A hike this morning would be the BoE's best option, however, Dales said.

Swissquote analyst Ipek Ozkardeskaya believes pound-dollar parity is "seen as almost certain".

"Normally, you would've expected a huge fiscal spending package from one of the biggest economies in the world to at least boost the equities and the pound. It could’ve boosted equities because the amount of money that will be pushed into the system should start going around the economy, and in businesses' pockets, and spur growth. But the FTSE dived near 2% on the news," Ozkardeskaya commented.

"And it should've boosted sterling, because such a huge fiscal spending would result in a decent response from the Bank of England… But the pound's just gone under the water."

Ozkardeskaya added: "The only hope here is to see at least a sugar rush in the British economy to help investors digest information, but the next couple of years will probably be harsh for the UK."

Dutch bank ING said sterling is part of a wider "race to the bottom" in the foreign exchange market.

The euro is similarly struggling against the dollar and is now solidly below parity.

ING added: "We think the dollar will stay strong in the near term and this should keep any recovery in EUR/USD quite short-lived. Risks of a break below 0.9500 this week are quite material.

"Needless to say, until a policy response is seen, cable will be biased to 1.00."

Cable refers to the pound-dollar exchange rate. The term is derived from undersea cables that linked the UK and US.

By Eric Cunha; [email protected]

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