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The Bank of England seems to enjoy keeping the market guessing. While other central banks deliberately prepare the way for their decisions, the BoE has administered short sharp shocks. Its decisions to raise its main bank rate in August and January took the market by surprise. Ahead of Thursday’s announcement from the Monetary Policy Committee, traders are almost evenly divided on the chance of a rate rise, pricing this possibility at about 40 per cent.
There is something reassuring about this. The BoE reserves the right to shock the market. This gives it more freedom of action. Any move it makes, with rates roughly neutral, will have more psychological impact if it comes by surprise. Ben Bernanke of the US Federal Reserve is trying to be open, while Jean-Claude Trichet of the European Central Bank flags rate moves a month ahead of time using the codeword “vigilance”. But such transparency does not stop heavy trading on the back of each new data item.
The MPC has a close call. House price inflation is still worrying and the economy shows signs of overheating, as witnessed by Wendesday’s survey of purchasing managers. But the BoE has reached the level, 5.25 per cent, at which the Fed stopped last year. The full effects of its earlier tightening may not yet have shown. A rise might push up the pound, which looks overpriced at $1.98.
The weight of speculative interest from hedge funds makes reaction in the forex market hard to predict. Look at Wednesday’s decision by the Reserve Bank of Australia to leave rates unchanged. The market had priced in a 50 per cent chance of a rate rise. At first, the Australian dollar sold off. But the “Aussie” has gained 16 per cent against the US dollar in the past year. Speculators like its high yield, particularly when they can fund Aussie investments by borrowing in yen (at minuscule rates). They saw the sell-off as a buying opportunity. Within hours, the Aussie was trading 0.7 per cent higher against the yen than it had been before the rate announcement. Whatever the BoE decides, the reaction is barely any easier to predict than the decision itself.