Trading Event: BoE Policy Meeting - Rate Rise Possible

The Bank of England's policy meeting in July will be Mark Carney's first since he has sworn in as the governor of the central bank. Although his predecessor, Mervyn King, was in favor of an increase in stimulus, Carney will likely stay out of it during this month's policy meeting and monitor the economic progress. However, he may announce other measures to speed up Britain's recovery.

During last month's policy meeting the Bank of England maintained that the UK has been undergoing "slow but sustaining" growth. BoE, which has set the inflation goal of 2%, was confident of achieving the target in the medium term. The central bank highlighted that the CPI inflation for April had fallen back by more than expected to 2.4% mainly due to the weakness in Average Weekly Earnings (AWE), and predicted a rise to 3% in the summer, with the indicator remaining well over 2% for the rest of the year. The Bank of England, however, noted that it needed to adjust the speed at which it wanted to achieve the inflation to the target by causing less market volatility, as possible. It described the situation as "one in which above-target inflation was accompanied by a degree of slack in the economy." The higher level of inflation played a major part in the Bank's decision against the consideration of additional stimulus, on top of the existing size of the asset purchase program of £375 billion.

Since the last meeting, the batches of economic data released in June have been positive. The CPI inflation reading has further jumped to 2.7% in May in line with the Bank of England's forecast of a temporary peak of 3% by summer. The UK manufacturing index hit a reading of 52.5, a level not seen in the past two years. Besides, other key indicators such as retail sales have also seen considerable improvements in May. Given the GDP data and labor market figures for the first quarter in 2013 were disappointing compared to the respective figures in 2012, the other batches of positive key economic data would keep the BoE to stay put when it comes to pouring additional stimulus into the economy. The central bank, via the Financial Stability Report, gave permission to all the banks to release £70 billion, which was mandated to be kept to ward off against the 2007 like credit crunch, hoping that the banks would lend a major chunk of this capital, that in turn would help in the economic recovery.

The central bank in its previous meeting also noted that there have been considerable economic improvements in the major economies such the US and Japan, however raised concerns over the need for the Euro area rebalancing. Since the last meeting, there has been some very bad economic data coming out of the US and China. The first quarter US GDP in 2013 has been revised down to 1.8% from 2.4%, while the Chinese economy, the second largest economy in the world, faces a credit crunch. The inter-bank borrowing rates shot up between 10% to 25% at one point when the Chinese central bank declined to step in to intervene the markets.

European markets on Wednesday also fell sharply owing to fresh fears from the political uncertainties of Portugal and Egypt.

Is a rise in the interest rates looming?

The Bank of England also told banks to ensure they would cope with any increase in interest rates, urging the financial institutions and authorities to fully ensure the risk involved from a sudden increase in the interest rates. This indicates that the rate rise may be looming. The recent volatility in the market has confirmed the investor anxieties over the upcoming policy decisions.

So how can you trade this event?

There are four possible outcomes the investors should be prepared for in order to profit from this event:

1. Decrease in rate by 25 bps to 0.25%:

Any decisions to cut down the interest rates will likely to rattle the GBP/USD pair, strengthening the USD dollar to move sharply to the next couple of immediate resistance points and the sterling may find it hard to withstand any selling pressure. However, the momentum in the US dollar could remain in check, thanks to the much awaited NFP payroll data release on Friday. Nevertheless, the UK, the Europe as well as the US stock markets will welcome such a decision with great relief, given there has been much anxiety over the past few weeks on the interest rate increase and stimulus cut-down allegedly being strategized by the central banks around the globe. This will definitely assure investors on the central bank thinking, i.e; not all central banks are looking to reverse their monetary policy strategy and this can be an influencing factor in the ECB monetary policy decision later in the day.

2. Rates remain unchanged at 0.5% but a dovish tone by the BoE:

Any dovish tone from the Bank of England will be seen as a good sign in getting the central bank support in the months to come, while the economy is still in its slow recovery phase. Consequently, the GBP/USD may pare some recent losses, but would await the ECB and NFP payroll decision to further decide direction of the sterling against the US dollar. The stock markets across the major economies likely to remain neutral.

3. Rates remain unchanged at 0.5% but a hawkish comment by the BoE :

Any hawkish tone by the Bank of England with any signs of tightening the £375 billion stimulus program will see sharp gains in GBP/USD pair in anticipation of an interest rate increase in the near future. The stock markets however would see a sharp sell off as investors are still expecting low interest rates and the asset purchases to be maintained by the BoE and other major economies, in order to achieve global growth.

4. Increase in rates by 25 bps to 0.75 %

Increase in the interest rates is not seen on the cards during this month's BoE policy meeting. However, if this measure is taken, it would be a game changer as this would be seen as the central bank's intention to wind down the £375 billion stimulus program to counteract the growing inflation and will certainly lead to a sharp sell off in the UK stock markets and other global markets may feel the pressure and follow suit as their respective monetary policies are due later in the month and the fresh fears from Portugal and Egypt will only aggravate the issue with investors fleeing with their money for safety and there would be an increased demand for the 'safe haven' US dollar.

Concluding comments

In summary, I believe the Bank of England may play the waiting game during this month's policy meeting, maintaining the base rate at 0.5%, with no change to the on-going asset purchase program of £375 billion, as any sudden reversal of policies may impact the recovering economy and the bank would like to see further moves by its counterparts across the globe, before considering any brave steps.