British pound surges as BoE pushes back against rate cuts

Pound sterling rallies vs. USD, EUR as Bank of England pushes back against rate cut expectations

The Bank of England (BoE) stuck to its position on Thursday, saying that interest rates in the UK should remain elevated for an "extended period”, a day after the U.S. Federal Reserve signalled forthcoming rate cuts in the United States.

In a 6-3 vote, the BoE's Monetary Policy Committee (MPC) opted to keep rates at a 15-year high of 5.25%, in line with market expectations. There was no deliberation on reducing interest rates, and the BoE expressed ongoing concerns that inflation in Britain might persist at a higher level than in the U.S. and the euro zone.

The BoE also largely shrugged off data showing a slowing wage growth and a 0.3% fall in gross domestic product in October, potentially pointing towards a pre-election recession in 2024.

The British pound strengthened by over half a cent against the U.S. dollar, rising to $1.27 and prompting investors to revise their expectations for the timing of the first Bank of England rate cut. Meanwhile, UK government bond prices retraced a significant portion of the gains recorded after the Federal Reserve's statement on Wednesday.

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UK monetary policy: BoE stance at odds with market expectations

The BoE's policy stance, which assumes a gradual decrease in UK interest rates to 4.25% over the next three years, sharply contrasts with current market expectations, which anticipate reaching that level before the end of the next year.

Governor Andrew Bailey said the central bank was firm in its intention to reach its 2% inflation target:

"Successive rate rises have helped bring inflation down from over 10% in January to 4.6% in October. But there is still some way to go. We'll [...] take the decisions necessary to get inflation all the way back to 2%.”

The policymakers who dissented in the vote wanted a further rate increase to 5.5%, while for most others, the decision not to raise rates was described as "finely balanced," according to minutes from their policy discussion.

The Bank of England’s primary message has remained unchanged since November, forecasting a two-year timeline for returning inflation to target levels. While acknowledging that near-term inflation might be slightly lower than previously expected, the BoE remains focused on longer-term concerns.

The BoE pointed out that, compared to the U.S. and the euro area, measures of wage and services price inflation in the UK were notably higher. However, British 10-year government bond prices have declined by a full percentage point since late October, reflecting market expectations of looser central bank policies both domestically and internationally.

The central bank acknowledged that bond yields had decreased "materially” and committed to taking that into account in its next quarterly forecast update in February. It also noted that a November 22 budget statement by Finance Minister Jeremy Hunt was likely to boost gross domestic product by a quarter of a percentage point over the coming years, with limited inflationary implications.

GBP forecast: Sterling’s outperformance against EUR and USD could prove short-lived, say analysts at MUFG

In a GBP forecast issued prior to the BoE’s announcement on Thursday, economists at MUFG wrote that the UK central bank’s firm stance could quickly turn dovish if growth figures prove insufficient, meaning the pound’s outperformance against the euro and dollar would likely end:

“Of the three major central banks we thought that the BoE would have the most credibility in pushing back against dovish market pricing that could help the pound to outperform both the euro and US dollar in the near-term based on the view that the risk of more persistent inflation in the UK currently appears to be higher. However, data releases in recent days have cast some doubt on the view that the BoE will lag the ECB and Fed in cutting rates next year.

After a poor start to the quarter, it looks likely that the UK economy will continue to stagnate at best in Q4 compared to the BoE’s forecast for a marginal pick-up in growth by 0.1%. While the developments are unlikely to stop the BoE from pushing back again today against earlier rate cut expectations, if the softening growth inflation data continues into early next year it will encourage the BoE more quickly into a dovish policy pivot. As a result. the near-term window for relative pound outperformance against the euro and US dollar could prove short-lived.”

At the time of writing, the GBP to USD exchange rate, widely known as “cable” in forex markets, traded around the $1.27 mark, with sterling up 0.66% against the dollar on the day. The euro to GBP rate also favoured the pound, with EURGBP trading at 0.8602, having slid by 0.22%.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.