ING expects the Bank of England to keep policy unchanged, with a 7–2 vote and a slight risk of 6–3, while adopting a hawkish tone as it attempts to ride out the current inflation shock. The bank forecasts UK inflation will peak near 3.5% later this year, and it does not expect that to prompt monetary tightening.
On FX, ING projects further downside in GBP/USD, describing a move towards 1.3200 over the coming weeks as the dollar strengthens against currencies where central banks are seeking to avoid tightening within the year, including Canada and Sweden. It also sees EUR/GBP skewed higher, with a bias towards 0.8680/8700.
Bank Of England Stance And Implications For Sterling
We see the Bank of England holding rates steady, even as the latest UK inflation data for May came in at 3.1%. The Bank will likely talk tough on inflation but ultimately avoid any policy tightening this year. This creates a clear weakness for the pound against currencies backed by more proactive central banks.
This cautious stance from the Bank of England is not new; we saw them hold rates in 2011 when inflation surged past 5%. They are betting that the current inflation spike is temporary and will fade without intervention. We believe this patience will translate directly into a weaker pound in the short term.
Monetary Divergence: Dollar And Euro Versus Pound
The US Federal Reserve is signaling more rate hikes to combat their own persistent 3.8% inflation, which will continue to strengthen the dollar. We expect this will push GBP/USD down towards the 1.3200 area over the next few weeks. Buying put options on the pound against the dollar is a way to position for this expected decline.
We also see the Euro gaining on sterling, with a target of 0.8700 for the EUR/GBP pair. The European Central Bank is sounding increasingly willing to tighten policy, creating a clear divergence with the Bank of England. Call options on EUR/GBP could be considered to capitalize on this potential move higher.
