On Thursday, the Bank of England is expected to raise interest rates for the first time since 2007.
Investors are debating whether this marks the beginning of a tightening cycle or whether the move is just a reversal of the hasty rate-cut in the weeks following the Brexit vote.
The UK economy has broadly defied expectations, fighting off the perils of Brexit. Policymakers are sensitive to the dangers of raising interest rates and nervous about tipping the balance for the UK’s economy.
The rate hike will soften the inflation data, which has touched the 3%-mark, way above the target mark of 2%.
Investors have been plunging bullish bets into the pound on the back of the expected rate hike. Momentum is starting to slightly fade however, as investors grow weary of the debate on future interest rates and the dollar starts to rebound.
However, any rally in the pound after the interest rate hike could be transitory as uncertainties prove too large to be dismissed.
Softer inflation, thanks to the rise in the cost of borrowing, will push the pound lower. Sterling has held above $1.30 in the run-up to the decision but could fall underneath this as Brexit unfolds and inflation readings dwindle.
Investors will also be looking at how close the vote to raise rates will be. A tight vote would suggest that further rate hikes in the near future will be unlikely. However, with price stimulation so high, one rate hike may not be enough.
On the other hand, the likelihood that Britain could leave the European Union in 2019 without a deal is rising and growth expectations for the UK’s economy are weak, this suggests that an extended increase to interest rates would be risky.
If the BOE decide to keep interest rates unchanged, the reaction could be considerable. We could see the cable and the euro-sterling plummet as the rate rise has already been priced into the market.