Bank of England policymakers face difficulties

[Ben Graham]

The pound has been trading with heightened volatility in recent days. Although the Bank of England is likely to hold its policy rate at 3.75% this week, policymakers must weigh conflicting signals that the economy is both strengthening and losing jobs while unemployment sits near a five?year high.

The Monetary Policy Committee has taken a cautious approach. Its nine members remain divided on the appropriate rate, with estimates of the neutral rate ranging from 3% to 3.5%. Minutes of the December meeting showed officials agreed to act more prudently unless the outlook shifts unexpectedly.

That caution reflects global economic uncertainty and unpredictable inflation dynamics. Like other central banks, the Bank of England faces the challenge of balancing support for growth with the need to contain inflation, which requires finely tuned policy judgments.

The split on the committee underlines the difficulty of the task. Some members favor tighter policy to bring down inflation, while others fear higher rates could choke off growth. The common thread in the minutes was a preference for a measured approach.

The key uncertainty remains the pace at which inflation will fall back to the 2% target from its current 3.4% reading.

New projections in the bank's quarterly monetary policy report, published alongside the rate decision on 5 February, will shed light on officials' assessments. The forecasts for wages will be a crucial piece of the puzzle. The Bank will also publish the results of its business?contacts survey, with planned pay deals under scrutiny.

Unemployment is currently 5.1%, a level last seen in early 2021. That suggests the annual jobless rate may exceed the Bank's November projection of 5% by the end of 2025.

Markets are pricing only one rate cut this year after the quarter?point easing in December 2025, a decision that narrowly passed and whose outcome was swayed by Governor Andrew Bailey's vote. All else equal, a higher policy rate supports sterling because it boosts the currency's yield appeal for investors.

A technical outlook for GBP/USD suggests that buyers of the pound sterling should aim to reclaim the nearest resistance at 1.3705. Doing so will open a path to 1.3738, above which a breakout would be difficult. The extended target is the area around 1.3784. On the downside, bears will try to seize control at 1.3670. If they succeed, a break of that range would deal a serious blow to bullish positions and could push GBP/USD down to 1.3640 with scope to extend to 1.3615.

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