BOE may join the gang and go dovish, weighing on the pound

• The BOE has been holding up its intention to raise interest rates.
• Uncertainty about Brexit and global headwinds may push the pound back to neutral.
• GBP/USD is vulnerable ahead of the decision.

The world’s most prominent central banks have turned dovish – and it may the Bank of England’s turn now. The BOE has been forecasting rate increases in the next few years to keep inflation and credit contained. The “Old Lady” has not acted due to Brexit uncertainty – which has paralyzed all policymaking. Nevertheless, Governor Mark Carney and his colleagues have been assuming a smooth Brexit and rate increases.

Fears about a potential hard exit from the EU and US dollar strength have pushed GBP/USD lower, but it could have fallen to even lower ground had it not been for this hawkish bias – and it may change now.

Reasons to drop the hawkish bias

The European Central Bank has moved from planning to raise rates in 2020 to perhaps cutting interest rates this year. The Federal Reserve is ready to “act as appropriate” and possibly slash rates, and central banks in Australia and New Zealand have already reduced rates.

The BOE is unlikely to take any action until it receives some clarity about Brexit – but it may change its language to something more neutral. Apart from aligning itself with its peers, the bank has genuine reasons to reduce expectations and move to a “wait and see” mode. Carney has already raised rates twice from the Brexit low of 0.25% to the current rate of 0.75%.

Fresh inflation figures for May have shown a slowdown to 2% – the BOE’s target – and prices are unlikely to rise. Also, the British economy squeezed by 0.4% in April and jobless claims are on the rise. On the other hand, the unemployment rate remains at historic lows of 3.8% and wage growth is above 3% year on year – a satisfactory rate.

Overall, the read of economic indicators does not seem to justify a hawkish bias – especially in the light of global headwinds and peers’ actions.

GBP/USD potential reactions

If the BOE removes its hawkish bias, the pound has room to fall, perhaps causing carnage as it will join Brexit uncertainty. The pound has been showing its vulnerability of late – falling not only against the mighty dollar but also against the euro and the yen.

However, if the bank fears criticism from politicians and opts to leave its statement mostly unchanged – GBP/USD has room to rise. In this case, the BOE would stand out among central banks. However, any gain may be limited.

It is important to note that the BOE makes its announcement fewer than 24 hours after the Fed decision – a more significant event – and movements in the currency pair may still reflect the previous night’s outcome.

Conclusion

The BOE is set to leave its policy unchanged but may drop its intention to raise rates in the future. Such an outcome would find a vulnerable pound and send the pound lower. Leaving the statement unchanged may result in short-lived gains.