Money markets are already embracing the message that prices will stay higher for longer ahead of the Bank of England meeting. Markets widely anticipate the bank rate to remain unchanged this time, but still see some chance of the central bank raising rates once again in the coming months. This outcome has approximately a 30% chance. Beyond that, markets are fully pricing in a first rate cut only in September next year.
Longer-term trailing rates, such as the 10-year Gilt yield, are closely correlated with the trailing rate, but are also seeing indirect effects from rising US yields become more relevant, especially over the last month . That said, the 10-year Gilt yield has moved in a sideways range since July. While it sits closer to the top of that range, it will probably need a bigger surprise from the Bank of England such as a hike to push yields substantially higher to, say, 4.8%, as yield patterns central bank holdings are developing on a more global level.
Given the other key developments next week, it will be difficult to separate the Bank of England’s long-term impact from other factors. But in medium-term models based on the money market curve, the 10-year Gilt yield has still shown a beta of 0.5 with 1-year and 1-month forward contracts currently roughly reflecting the future horizon. in which the markets discount the first cut.
In currency markets, the BoE’s sterling trade-weighted index has remained on the soft side of tight ranges throughout October. We doubt a hawkish stance on Thursday will have much impact on the pound, but we outline its path under the alternative scenarios mentioned above. We still have a year-end EUR/GBP forecast at 0.87 and a view that it could trade as high as 0.90 next summer as the market moves to pricing in a more traditional Bank of England easing cycle.
One more point is that GBP/USD is showing a reasonably high positive correlation with US stocks, and warns that sterling may underperform a bit if the equity sell-off gains strength. Our base case assumes GBP/USD ends the year at 1.22, but an intra-month decline to 1.1750 is possible if conditions in global stock markets deteriorate further.