UK Interest Rate Decision: Will the hawkish side strengthen?

After the European Central Bank interest rate decision last week eyes now turn to the Bank of England interest rate meeting. While the UK economy battles to recover from recession, the country's price levels accelerated creating a problematic situation for the BoE. The question on everyone's minds is whether the BoE is going to make the first move and lift interest rates after nearly two years of a loose monetary policy.

Policymakers are concerned about the rising price levels. Consumer Price Index (CPI) revealed that the country's inflation rose as high as 4% while the central bank's target is only at 2%. Speculators forecast that the CPI figures will move higher in the following months putting the BoE under mounting pressure to lift the country's interest rates soon. An important factor that adds further inflation pressure on the BoE is the surging oil prices. Due to the geopolitical unrest in Libya, which is one of the largest oil producing countries in the world, oil prices surged to two year highs. Tensions are slowly spreading to Saudi Arabia, the largest oil exporter in the world, pushing prices further high. One can not help but wonder 'how high can the oil go?'. It is now the time for the BoE to face the dilemma and decide whether to adjust its monetary policy to correspond with the upward inflation risk. At February's interest rate meeting, another member joined the hawkish side of the dilemma and three of the nine members voted for a tightened monetary policy. Will the hawkish side strengthen this week and will we witness rates going up at Thursday's meeting?

This is not an easy decision for the central bank. In normal economic conditions when inflation is rising, interest rates rise. But after the fourth quarter Gross Domestic Product (GDP) shocked the markets by showing a disappointing 0.6% contraction of the economy, policymakers are afraid that the economy may face a double dip recession. Can the UK economy handle an increase in interest rates while it struggles to escape recession? A rate hike may prove to be negative for the UK economy which suffers from slow growth and a stubbornly high unemployment. Recent data showed poor retail sales and a weak housing market underscoring the country's fragile economic position. To make matters worse, the UK risks falling into a dangerous stagflation phase. Stagflation is when an economy suffers from rising price levels and slow growth. It is a troubling economic state that an economy will find difficult to escape from. The central bank is now asked to find the healthy balance between rising oil prices and a sluggish economic growth.  

Whether the BoE announces interest rates higher than the all time low of 0.5% we will know on the 10th of March at 12 GMT. Speculators expect the BoE monetary policy committee to keep rates unchanged but the possibility of a surprise rate hike always exists in investors' minds. If policymakers surprise the markets and increase rates at Thursday's meeting, the sterling may jump and face fresh highs. Whatever the outcome, it will certainly be an interesting day to trade the currency markets!

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