The Bank of England (BOE)

The Bank of England (BOE) is the UK’s central bank. Their mission is to promote and maintain monetary and financial stability. It is important for forex traders to keep up to date with the Bank of England’s latest changes to monetary policy because it can have a large effect on the Sterling Pound (GBP) and relevant currency pairs, like the EUR which is highly correlated to the Pound.

What is the BANK OF ENGLAND (BOE)?

The Bank of England (BOE) is the central bank of the United Kingdom. Established in 1694, the BOE serves as the banker to and is owned by the British government, but it operates independently when setting monetary policy.

The Bank’s key responsibilities include:

  1. Setting monetary policy – This involves targeting interest rates and utilizing other tools to stimulate or contract the economy.
  2. Issuing the UK’s banknotes.
  3. Supervising certain bank payment systems.
  4. Ensuring the stability and safety of the financial system.

For traders, the BOE’s monetary policy decisions are a critical factor to consider, as they can have a significant impact on financial markets. Other factors, such as the independence of the central bank, are also important considerations, though they tend to be more prominent issues in emerging market economies.

The independence of the central bank in setting monetary policy is a crucial characteristic that distinguishes developed economies like the UK from many emerging markets, where political influences can sometimes interfere with monetary policy decisions.

Key Economic Mandates of the Bank of England

According to the Bank of England, their two core purposes or mandates are:

  1. Monetary Stability – This refers to price stability or inflation control.
  2. Financial Stability – This is concerned with the stability and health of the overall economy.

Monetary Stability

Monetary policy is extremely important for the entire economy. It helps prevent runaway inflation and attempts to anchor inflation expectations, allowing the economy to grow at a sustainable pace. To maintain price stability, the Bank of England and their Monetary Policy Committee (MPC) have set an inflation target of 2%.

If inflation rises above the 2% target, the Bank of England may opt to increase interest rates. This increase in interest rates can lead to an appreciation of the Pound, as investors channel more capital into the higher-yielding currency. It may also have a negative impact on the stock market, as businesses face higher borrowing costs and equity valuations are discounted at a higher rate. Monetary policy data can be found on the Bank’s economic calendar.

However, it is not always the case that the Bank will raise interest rates when inflation is above target. In some situations, such as when GDP growth is still low or negative, the Bank may choose to keep rates low in order to stimulate the economy. It is important to understand that the Bank of England aims to strike a balance between maintaining healthy inflation and promoting economic growth.

Financial Stability

The resilience of the financial system is paramount to the health of the UK economy, and therefore it is a key priority for the Bank of England. To support its Financial Stability mandate, the Bank has established a Financial Policy Committee (FPC), which was introduced in June 2011. From an FX trader’s perspective, Monetary Stability is the primary driver of spot exchange rates for the Pound Sterling (GBP).

How BOE Interest Rates Affect the Pound

Interest Rate Impact on the Pound

The Bank of England can affect the value of the Pound through changes in interest rate expectations. Traders should understand that currencies appreciate when interest rate expectations increase, not just from increases in the nominal interest rate.

MARKET EXPECTATIONSACTUAL RESULTSRESULTING FX IMPACT
Rate HikeRate HoldDepreciation of currency
Rate CutRate HoldAppreciation of currency
Rate HoldRate HikeAppreciation of currency
Rate HoldRate CutDepreciation of currency

For example, if the Bank of England keeps interest rates unchanged but issues forward guidance (communicates to the market) that they expect more interest rate hikes in the future, the value of the Pound will appreciate. Likewise, decreases in expected future interest rate hikes, or expectations of an interest rate cut, can lead to a decrease in the value of the Pound.

This is the general principle for how interest rates affect the Pound and the stock market, although their reactions can sometimes differ:

  • Higher interest rate expectations increase the strength of the Pound (GBP) but negatively impact equity values.
  • Lower interest rate expectations decrease the strength of the Pound (GBP) but positively impact equity values.

Interest rates are not the only monetary policy tool that can affect the currency. Tools like quantitative easing (QE) can also lead to increases and decreases in the value of a currency. If the Bank of England announces plans to start a QE program, the Pound will likely depreciate as the increased money supply leads to lower interest rates or a maintenance of current rates.

Interest Rate Impact on the Economy

The Bank of England lowers interest rates when it is trying to stimulate the economy (GDP) and increases rates when it is trying to contain inflation caused by an economy operating above potential (overheating).

Lower interest rates stimulate the economy in a few ways:

  • Businesses can borrow money and invest in projects that will receive more than the borrowing rate.
  • The stock market is discounted at a lower rate, leading to an appreciation in stock market values and a wealth effect.
  • People invest more into the economy (stocks and other assets) because they can earn higher returns than the currently low interest rates.

How to Trade BOE Interest Rate Decisions

The table below displays the possible scenarios that can arise from changes in interest rate expectations. Traders can use this information to forecast if the currency is likely to appreciate or depreciate, and how to trade it accordingly.

For example, on August 4, 2016, the Bank of England cut interest rates and announced a stimulus package (quantitative easing program). The market reacted negatively, and the Pound depreciated.

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