This week’s meeting of the Bank of England’s Monetary Policy Committee (MPC) offers the central bank an “ideal window” for an interest rate hike, according to ETX Capital’s Neil Wilson.
The likeliest outcome is that the MPC chooses to raise interest rates, said the senior market analyst, with overnight index swap markets suggesting an approximately 90 per cent chance of a 25 basis points hike to 0.5 per cent.
Indeed, while markets can get it wrong – and there is a risk of no hike given the Brexit uncertainty and signs of weakness in some quarters of the economy – much of the rhetoric from governor Mark Carney seems to support a rate rise.
Wilson said: “After September’s hawkish hold, a dovish hike in November is expected with the Bank set to raise rates but sound cautious on the outlook for future hikes.
“November is the ideal window of opportunity to raise rates so that the MPC has ammunition in the event of an economic downturn to ease again.”
But there are a lot of moving parts for investors to keep an eye on. Below FE Trustnet considers some of the potential scenarios that may arise and what they could mean for investors.
There are several scenarios that could have implications for markets, beginning with whether an interest rate rise is a one-off or whether it starts a slow but steady interest rate hike cycle.
“Sterling ought to be lifted if interest rates rise, but the currency is also sensitive to the nature of the vote split and any ‘forward guidance’ from the Bank on possible future hikes,” Wilson said.
Sterling has been under pressure since the UK voted in favour of leaving the EU last year, losing 10.83 per cent against the US dollar, as the below chart shows.
Performance of sterling since Brexit vote
Source: FE Analytics
However, there is no consensus on whether a 25 basis point rise would lead to a cycle and therefore a more dovish outlook could be a net negative point for the currency while a hawkish rhetoric could boost the currency.
“At present overnight index swap markets indicate a roughly one-in-three chance of at least two further hikes in 2018, but a roughly 75 per cent chance for one more hike,” said Wilson. “This vote and the communication have the potential to shift these expectations and sterling with them.”
“In terms of the voting split, a tighter vote may be sterling negative. An eight-to-one split would signal confidence in the economy and therefore the possibility of further hikes in 2018, even if the official communication on this front is more cautious.”
This is important for investors to take into account, with UK large-cap stocks more likely to benefit from a weakening sterling thanks to their overseas earning potential.
Performance of indices since Brexit vote
Source: FE Analytics
Meanwhile, a stronger pound should benefit the more domestic-focused mid and small caps as it would make the relative costs of imports cheaper.
Of the MPC members, Ian McCafferty and Michael Saunders are the two most hawkish members having already voted for rate hikes this year and are likely to be joined by Andy Haldane who has described an interest rate hike as a “good news story”.
“With those three in the bag, the key question regards whether we get a hike is whether Mark Carney, Ben Broadbent and Gertjan Vlieghe join the hawks. The indications are that they will, but risks remain,” ETX Capital’s Wilson said.
“Broadbent has been quiet and his view will be important – if he votes for a hike he may swing the vote more decisively in favour of the hawks, which would be more sterling-positive.”
Three members are more dovish: deputy governor Jon Cunliffe, fellow deputy governor Dave Ramsden, and new member Silvana Tenreyro.
“Therefore there is a chance of three members voting against a hike. If three do go against a hike it could be bad for the pound as it may be regarded as a signal that in the absence of broad consensus this is not the start of a tightening cycle. 
“Further hikes would come into question. However, if either Cunliffe and/or Tenreyro go for a hike it may be taken as considerably sterling-positive as this scenario would support consensus around further hikes.”
However, there remains a small chance that the MPC may indeed decide not to vote for an interest rate hike.
“There is a small but significant chance the MPC members get cold feet and decide that tightening now would be too soon,” Wilson said.
“Wage growth is faltering, retail sales are starting to buckle and no deal has yet to be negotiated on Brexit. There is considerable pressure coming from some corners of the business community to avoid raising rates. The MPC members will certainly be listening and they will no doubt be aware of the history of central banks tightening too soon.
“Above all the threat of a no deal breakup with the EU looms but this is unlikely to form the base case for the Bank.
“It would also be mindful that with reasonable solid economic fundamentals and inflation at 3 per cent and likely to fall, November is the ideal window of opportunity to raise rates so it has ammunition in the event of an economic downturn to ease again.”