Pound Sterling Gains on Inflation Warnings and Slow Pace of Cuts

November 8, 2024 - Written by Frank Davies

STORY LINK Pound Sterling Gains on Inflation Warnings and Slow Pace of Cuts

The Bank of England (BOE) Monetary Policy Committee (MPC) cut interest rates by 25 basis points to 4.75% which was in line with strong consensus forecasts.

There was an 8-1 decision for the cut with Mann voting to hold rates at 5.00%.

The Pound had drifted lower into the announcement and there were significant gains after the decision with a covering of short positions and a relatively hawkish statement helping to trigger fresh buying.

Markets consider that the chances of a further rate cut in December are only around 25%.

The Pound to Dollar (GBP/USD) exchange rate rallied to around 1.2940 from 1.2900 immediately before the announcement.

The Pound to Euro (GBP/EUR) exchange rate also strengthened to near 1.2020 from 1.1990.

ING noted the threat of near-term volatility, but added; “Medium term, however, we increasingly expect EUR/GBP to prove a 0.82/83 story as the fall-out of trade wars weighs more heavily on the euro than the pound.” (Potential GBP/EUR gains to 1.22)

UK bonds registered fresh losses with the 10-year yield at a fresh 12-month high of 4.55% while the FTSE 100 index moved lower.

According to the Committee; “there has been continued progress in disinflation, particularly as previous external shocks have abated, although remaining domestic inflationary pressures are resolving more slowly.”

The bank expects that the recent budget measures will put upward pressure on labour costs and have a direct impact on prices.

Although the impact is uncertain it considers that inflation overall could be 0.5% higher than expected previously.

The 2024 GDP forecast was cut to 1.0% from 1.25%, but the 2025 projection was raised to 1.5% from 1.0% previously.

According to the bank, a gradual approach to remove policy constraint remains appropriate while Governor Bailey added that it is likely that rates will continue to decline gradually if the economy evolves as expected.

Bailey repeated that disinflation has been faster than expected, but again warned that rates should not fall too fast or too far and that services-sector needed to declined further.

According to the majority; “There had been continued progress in disinflation, particularly as previous external shocks had abated, although remaining domestic inflationary pressures were resolving more slowly.”

Mann, who dissented, was uneasy over the budget impact and commented that CPI inflation was projected to remain above the 2% target until the end of the forecast period.”

Markets cut the potential for a further December rate cut slightly to around 25%.

According to HSBC, Director of Investment Strategy Hussain Mehdi; “A cooling labour market should help maintain downward pressure on services inflation in the coming months. But the latest UK budget is likely to add to inflationary pressures over the longer-term.”

He added; "What likely follows, in our view, is a fairly shallow easing cycle for the BoE and upward pressure on bond yields. Policy rates could settle comfortably above 3%, contrasting with the sub 1% period before the pandemic."

Danske Bank sees scope for Pound gains; “We think the main aim will be to calm markets following the release of the budget, highlighting a gradual easing of monetary policy. More broadly, we expect EUR/GBP to move lower in the coming quarters driven by UK economic outperformance, BoE lagging peers in an easing cycle for the time being and tight credit spreads.”

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