Bank of England's Interest Rate Decision and Its Currency Market Impact

Posted on the 2nd November 2023 by Hamish Anderson in Founders' blog, General news, News, Business, Finance, Founder Insights

In today's global economy, the decisions made by central banks can have an impact on businesses worldwide. One such decision was made today by the Bank of England when it chose to hold interest rates steady at 5.25%. While this might seem like an obscure financial matter, the implications are far-reaching, particularly for currency markets. In this blog post, we will contemplate the Bank of England's decision, its influence on currency markets, and why businesses should pay close attention.

The Bank of England's Decision

The Bank of England (BoE) is the United Kingdom's central bank, responsible for setting monetary policy to achieve its mandate of maintaining the stability of both prices and the financial system itself. One of the primary tools at its disposal is the setting of interest rates. Today, the BoE decided to hold its benchmark interest rate at its current level of 5.25%.

This decision comes amidst a backdrop of increasing global economic uncertainty, and the BoE's choice to maintain interest rates reflects its desire to reduce inflation, with the minimum negative impact on economic growth.. While UK core inflation is high enough to argue for a rate increase, the Monetary Policy Committee (MPC - the group of nine economists, central bankers and external experts which votes on changing the core rate) reasoned that doing so  might also slow economic growth and impact currency markets.

Impact on Currency Markets

Currency markets are highly sensitive to central bank decisions, and the Bank of England's choice not to raise interest rates will certainly have implications for these markets. Here's how:

1. Exchange Rates: Interest rate differentials play a significant role in determining exchange rates. When a central bank raises interest rates, it typically attracts foreign capital seeking higher returns. This can strengthen the domestic currency. Conversely, when rates remain unchanged, there is less incentive for foreign investment, potentially leading to a weaker currency.

2. Currency Volatility: Currency markets can experience increased volatility around (and immediately after) central bank announcements. The anticipation and reaction to rate decisions can lead to rapid currency fluctuations, creating both opportunities and risks for businesses engaged in international trade.

3. Import and Export Costs: A weaker domestic currency can make exports more attractive to foreign buyers. Conversely, it can increase the cost of importing goods and materials, affecting a company's supply chain and profitability.

Why Businesses Should Care

The Bank of England's interest rate decision may seem like an abstract concept, but it holds significant relevance for businesses. Here's why you should pay attention:

1. Forex Risk Management: Businesses engaged in international trade, or which have overseas competitors, are exposed to currency risk. The outcome of central bank decisions can lead to currency fluctuations, affecting costs, profit margins and ultimately commercial viability.  Effective forex risk management strategies allow businesses to manage volatility and mitigate such risks.

2. Strategic Planning: Currency movements impact the competitiveness of your products or services in foreign markets. A strong or weak currency can alter your strategic plans, including pricing strategies, market expansion, and investment decisions.

3. Financial Health: While the BoE has held rates today, the base rate rose from 0.1% to 5.25% in the space of just 22 months. The cost of borrowing, which is generally linked to the base rate, is at a 15 year high, and the speed of the increases has taken businesses by surprise and made hedging almost impossible. Begbies Traynor, the insolvency consultancy, reported yesterday that businesses operating on thin margins since coming out of Covid two years ago are increasingly distressed. 

4. Investment Opportunities: Changes in currency markets may also present investment opportunities. For instance, a weaker domestic currency could make overseas investments more attractive, while a stronger currency could favour repatriating profits.

Conclusion

The Bank of England's decision to hold its core rate at 5.25% is a key event that has a ripple effect on the global financial system. Currency markets are particularly sensitive to central bank decisions, and businesses involved in international trade can be significantly impacted. Businesses that stay informed about central bank decisions, understand their implications, and implement sound risk management strategies will be better positioned to succeed.