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As the Bank of England (BOE) prepares to raise interest rates for the first time in a decade, sterling could jump if Governor Mark Carney signals that several rate hikes lie ahead.
Market expectations indicate a 90 percent chance that the BOE will announce a rate hike Thursday, after the central bank suggested in September that strong inflationary pressures and better-than-expected growth since last year's Brexit vote could lead to a slowdown in monetary stimulus.
"We shouldn't expect a major re-pricing if the BOE simply does what the market is expecting," Kallum Pickering, senior U.K. economist at Berenberg, told CNBC. This means that the FTSE100 and sterling should not change dramatically if Carney announces a 25 basis point hike.
"However, I think the BOE could signal that the market pricing is still below what the BOE expects in terms of the path for future rate hikes. If the BOE sends a strong signal that the market is under-pricing the number of rate hikes, then sterling could appreciate," Pickering said.
Market expectations project only one rate hike in 2018, but if inflation remains above the bank's 2 percent target and households continue borrowing more rather than saving, the BOE could be forced to tighten its monetary policy at a faster pace, Pickering said in a note released Monday.
"A series of gradual rate hikes seems appropriate given the outlook for stable real GDP growth, above-target inflation and full employment," he said, forecasting two hikes of 25 basis points in 2018 and another in 2019.
This is because higher interest rates tend to reduce the money available in people's pockets as mortgages and credit become more expensive. In turn, this would control the increase in credit seen in the U.K., where data released Monday showed annual consumer credit at 9.9 percent in September, with a jump in borrowing on credit cards, overdrafts and unsecured loans.
However, some analysts believe that the BOE will not pursue an aggressive monetary policy because the economic conditions, such as substantial wage growth, are simply not there. As a result, Carney's communication is unlikely to signal more than another hike next year, if that.
"I'd be surprised if markets react too much on Thursday," Mike Bell, global market strategist at JPMorgan Asset Management, told CNBC Tuesday. He added that he does not believe that an aggressive hiking will take place, given that wages would have to increase significantly for that to happen.
"If they don't hike, sterling would fall," he added.
Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, told CNBC Tuesday via email: "I don't think the MPC (monetary policy committee) will talk sterling higher by signaling rates need to rise at a faster rate than markets now expect."
"Markets already expect interest rates to rise again in about six months' time, so talk of further rate rises will not necessarily boost sterling," he added.
JPMorgan's Bell said that the BOE is in a "very hard place" because its most important economic event — Brexit — is far from being settled.