The Bank of England, or BoE for short, is the Central Bank of the United Kingdom.
As the institution with the ability to control the supply of sterling pounds (British pound, or Great Britain pound), the BoE exerts great influence in the markets.
But what makes the Bank tick?
And how can you use this information to make some pips?
According to the BoE’s official website, its mandate is to:
“Promote the good of the people of the United Kingdom by maintaining monetary and financial stability”.
In short, they care about inflation.
Actually, the reason Central Bank’s exist is for the purpose of maintaining price stability -keeping inflation low, but positive.
And as such, most Central Banks have the mandate to maintain monetary (price) stability.
However, there are Central Banks which also have additional mandates, such as the Federal Reserve which also seeks to uphold economic growth.But enough about other Banks, we are talking BoE and GBP here.
And they care about inflation. Plain and simple.
Does this mean most data releases won’t matter?
Yes and no.
For the most part, no.
However, if you’ve read any of my economic indicator pages, you’ll know what matters when it comes to data and exchange rates:
Central Bank caring about the particular outcome of such data.
And while the BoE cares about inflation first and foremost, it will check other statistics for signs of potential inflation.
For example, tightening of labor market usually precludes increased inflation.
Thus, not all is lost when it comes to data releases in the U.K.
now, we need to check the Bank of England’s structure.
The bank is a corporation owned by the British government.
It’s been given its faculties (or abilities) by legislation, which means they have to serve their mandate (of helping the people) by law.
The decisions which matter are those concerning interest rates.
Such decisions are taken by the Monetary Policy Committee (MPC).
This MPC has 9 members, including the governor of the BoE.
Since currency markets are reigned by interest rate decisions, FX traders keep a watch on MPC members, their stance, and their past voting behavior.
This is all in an effort to predict how the next rate decision will go.
Oh. That’ true, I forgot to say:
Rate decisions are determined by votes of MPC members eight times a year (according to the official webpage).
So, eight times per year, MPC members get together to discuss and ultimately vote on whether to:
1. Increase rates
2. Decrease rates
3. Leave rates unchanged
it is very important to stay tuned to how the MPC is composed before a decision
As I write this, the BoE will make an interest rate decision in less than 24 hours.
So, how do we take what we learned here to prepare to trade this event?
Let’s start with inflation.
At this point in time, the Bank of England’s target for inflation is 2%.
However, inflation numbers have been too strong recently, with CPI reading 2.6%.
The BoE has been considering hiking rates because of this overshoot in inflation (remember their mandate of price stability).
Will they hike?
Consensus is they will leave rates unchanged (at tomorrow’s meeting).
You must consider they can wait to raise rates at a later MPC meeting.
So what determines their willingness to wait?
In this case, while the CPI came out strong, wages have not grown accordingly.
What does this mean?
It means prices are generally going up faster than wages.
Hence, the average person has less purchasing power (this goes against their mandate).
If the Bank hikes rates, it will decelerate inflation (good).
But it would also cut growth, and thus, decelerate wage increases (bad).
Therefore, increasing rates right this moment might not be the best thing to do, since the Bank can wait to see if wage growth picks up before hiking rates.
Further complicating matters, forecasting is made more difficult at this point in time, since Brexit negotiations are taking place.
The uncertainty stemming from this geopolitical issue further convolute matters, thus supporting a more “let’s wait and see” view by MPC members.
In the spirit of using this example to show how to benefit from knowledge:
6 out of the 9 MPC members are expected to vote for no change in rates tomorrow.
And 2 of them will likely vote for a hike (there are empty seats sometimes).
Could we get a surprise?
If we do, that will make for a great trading opportunity.
The expectation is for no change, so if they hike, GBP will go up.
Cutting rates is out of the question for this particular meeting so we will not contemplate this scenario.
And if things go as expected?
We will dive into the press conference by the Bank’s governor.
This will give us clues into what the MPC is thinking: as in, are they much more likely to hike next meeting?
so, the pound could gain in anticipation, but if the governor’s language is
more dovish (more wait and see, not so in favor of hiking next time), the pound
may lose ground.
11th Doctor anyone?
Ok, this tour of the Bank of England was short and sweet. Let’s visit other Central Banks.
The Forex Economist
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