The Bank of England (BoE) delivered a triple rate hike in November, its largest single increase since 1989 and the eighth in a row, as inflation grew at a double-digit rate and was more than five times higher than its 2.0% target. Although growth in consumer prices pulled a bit lower in November, it will remain problematic. According to the central bank’s projections, inflation may slightly overshoot its target in two years if rates stand at 3.0%. Hence, although the impact of past rate increases has yet to come through, the tightening phase will continue.

The next question that jumps to mind is how fast and how far policy tightening will go in an uncertain economic and geopolitical environment. Global signs of peaking inflation, slowing jobs growth and concerns about an imminent recession made the Fed and other major central banks intent on cooling the pace of rate increases this month while remaining steadfast in their price stability goal. Although the BoE’s communication has been relatively less clear, policymakers acknowledged in November that substantial progress has been made in reducing stimulus, signaling a potential pivot to smaller rate increases. They also played down a rate peak at 5.25% next year, claiming that markets are ahead of the central bank’s plans.

Investors are currently providing a probability of 72% for a softer 50bps rate hike to 3.5% on Thursday, with the remaining 28% assigned for a second 75bps rate hike. The final decision, however, might not be straightforward, with investors speculating a three-way or even a four-way split within the rate-setting committee. On the one hand, a second 75bps rate hike cannot be ruled out as rising wages increase the risk of a new inflation wave. December could prove to be the worst month of labor strikes for higher payments in more than a decade amid the cost-of-living crisis. Energy subsidies, which will extend to the first quarter of 2023, could also support consumption, delaying any price declines.

On the other hand, some doves could vote for a 25bps rate increase or no changes at all due to fears that past rate increases could backfire next year, potentially causing negative economic shocks in the fragile UK economy. During his Autumn statement, the new Chancellor admitted that the economy is already in recession, with the confirmation expected at the start of next year, when the October-December GDP data come out. Note that the three-month GDP average to October revealed a slight contraction of 0.3%. Friday’s preliminary PMI figures for December could lay out fresh evidence for the final quarter of 2022, with estimates pointing to a slight deterioration after November’s soft pickup.

As regards the impact on the pound, there won't be any new projections or a press conference following the rate announcement. Hence, the policy statement might be vital in navigating the currency during the post-FOMC session. Should the board view a potential recession as part of its price stability mission, leaving the door open for additional aggressive rate increases in 2023, pound/dollar might advance towards May’s high of 1.2665. Note that the pair is currently testing the key 50-weekly moving average (SMA) at 1.2370, which was a key bearish pivot territory a year ago. The FOMC rate decision could also be critical in determining whether this is a make-or-break point for the pair.

Alternatively, a hawkish Fed and a cautious rate hike by BoE could be a toxic cocktail for pound/dollar. In this case, the 1.2285 constraining zone will be closely watched ahead of the 20- and 200-day SMAs at 1.2100. Even lower, the pair may stabilize around 1.1940.