Since the beginning of the month, the British pound has staged a dramatic rally against the U.S. dollar on the belief that the Bank of England will have to raise interest rates very soon. In slightly more than a month, the GBP/USD has rallied from a low of 1.54 to a high above 1.6250. Interest rate futures show that investors are looking for 3 quarter point rate hikes from the BoE this year, which would make them one of the most aggressive G7 central banks. However this hawkish expectation from investors is completely at odds with the sentiment in the Bank of England. Monetary policy makers are convinced that the rise in inflation pressures is temporary and therefore does not necessitate action by the central bank. However two members have already dissented from this majority view and more could follow.
The Bank of England’s monetary policy is in focus this week because they have a monetary policy meeting but no changes are expected to made. However the pound has held onto its gains after the Shadow Monetary Policy Committee voted 5-4 to raise interest rates in Feb. At this point, you may wonder, who makes up the Shadow MPC and whether they even matter at all.
The Shadow Monetary Policy Committee (SMPC) is a group of independent economists in the U.K. that meet at the Institute of Economic Affairs, to discuss the state of the international and British economies. Their first meeting was held in 1997 and have met once a month since then. The decisions and minutes of the SMPC are published a few days before the Bank of England’s own interest rate decision and are oftentimes referred to as a guide for what the MPC could do. Like the Monetary Policy Committee, there are 9 voters at each meeting.
For the first time in this cycle, the Shadow Monetary Policy Committee has voted to raise interest rates. The decision was not unanimous with 5 members voting for a rate hike and 4 voting against it. Although the shadow council failed to predict the last 2 rate cuts by the MPC, their decisions matter because it helps investors get a sense of what intelligent economists who follow the U.K. economy closely are thinking. According to the SMPC, there were 3 main reasons why the 5 members voted for a rate hike:
1. Threat to the Credibility of the Inflation Fighting Mandate of the Central Bank
2. They believe that the greater risk for the global economy is overheating than depression
3. They believed that the slide in the GBP reflected the laxity of the U.K.’s monetary policy compared to other countries
Although the chance of the BoE actually raising interest rates is slim, what the SMPC votes tell us is that we are getting closer to a possible rate hike. This means that hawkish comments from central bank officials could easily set off additional gains in the GBP/USD that could cause the currency pair to challenge its November highs.