Sterling cuts earlier losses as BoE holds rates steady

Gilt yields tick higher, sterling rises after Thursday’s BoE meeting

Yields on British government bonds increased, the pound recovered some of its initial losses, and UK stocks trimmed their earlier advances on Thursday following the Bank of England's decision to keep interest rates on hold.

The central bank said it wanted more evidence of inflation realigning with its target before considering interest rate cuts.

The pound was lats 0.15% down against the dollar after the announcement, with the GBP/USD rate at $1.2669 — an improvement from $1.2635 prior to the decision. Sterling slid against the dollar following the Federal Reserve meeting on Wednesday, with U.S. policymakers announcing that they would keep interest rates elevated for the time being and Chaiman Jay Powell brushing aside expectations of a rate cut by March.

Against the euro, sterling was virtually unchanged for the day, with the EUR to GBP rate at 85.42 pence (+0.15%), having been weaker at 85.58 pence before the decision.

The Bank of England's Monetary Policy Committee saw a split decision, with six out of nine members opting to keep the interest rate at a 15-year peak of 5.25%. Jonathan Haskel and Cahterine Mann voted for a 0.25 percentage-point hike, while Swati Dhingra voted for a cut of the same size.

Jane Foley, head of FX strategy at Rabobank, commented on the dynamics to Reuters:

"I think the market is very focused on the voting pattern and that two members still voting for a hike, has led the market into thinking that there was a slightly hawkish element. If you remove the voting pattern much of the rhetoric is fairly unsurprising,"

This marked the first occasion since August 2008 — at the onset of the global financial crisis —that the committee's members voted both for and against changing interest rates in the same session.

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BoE drops “further tightening” warning, Andrew Bailey says more evidence needed for cut

Following the meeting, market participants scaled back their expectations of an interest rate cut by the Bank of England in May. The likelihood of a cut by May, as inferred from derivatives market pricing, dropped to about 50% from a two-thirds chance prior to the meeting.

BoE Governor Andrew Bailey, who voted to hold rates steady, commented on the decision:

"We need to see more evidence that inflation is set to fall all the way to the 2% target, and stay there, before we can lower interest rates”.

In a marked softening of its stance, the BoE dropped its previous warning that "further tightening" may be necessary should more persistent inflationary pressures arise. Instead, the Bank of England said it would "keep under review for how long Bank Rate should be maintained at its current level".

Authorities at both the U.S. Federal Reserve and the European Central Bank have been more explicit that reductions in interest rates are on the agenda. The Federal Reserve announced late on Wednesday that it has reached the peak of its current interest rate levels, with plans to decrease them later in the year.

Ian Stewart, chief economist at Deloitte, explained the reasons behind the BoE’s caution to Reuters:

"The balance of argument is edging slowly towards rate cuts, but the Bank cannot risk cutting rates and then having to raise them again as inflation revives”.

Post-announcement, the yield on the 10-year British government bond, or gilt, rose by approximately 2 basis points to 3.82% — up from 3.79% before the decision.

The UK’s blue-chip FTSE 100 index saw a slight increase of 0.35%, moderating some of its initial gains following the bank's meeting.

GBP forecast: Standard Chartered says EUR/GBP will trade under 0.9000 by early 2025

In a GBP forecast issued on February 1, analysts at Standard Chartered said they saw the EUR to GBP pair depreciating to just under 0.9000 by early 2025 as they forecast the BoE cutting rates at a quicker pace than they had previously expected:

“We already expect EUR/GBP to depreciate to just under 0.9000 by early 2025. The more rapid pace of easing that we now see adds a little more risk of GBP underperformance in coming months.

Most of the risk is concentrated in the next quarter or two, where our forecast has GBP firming slightly against the USD. We do not see major downside risk, rather risk that GBP keeps treading water at current levels”.

Sterling forecast: ING says EUR/GBP could trade in 0.85-0.87 range, GBP/USD near 1.26-27

In a post-BoE meeting review on Jan. 1, Chris Turner, Head of Global Markets at ING, as well as the bank’s Senior Rates Strategist Benjamin Schroeder, wrote that the UK will likely be playing catch-up with the U.S. and Eurozone with regards to disinflation, which will have an impact on sterling:

“Money markets shaved off 3-4bp of its pricing for the May meeting so that the implied probability of a first rate cut then now stands at around 50%, down from more than 60%. That puts it back to where we were around the middle of last week. June pricing was pared, but a cut by this date remains more than fully discounted. The discount over the entire year did nudge up a bit, but it remains above 100bp of easing. [...]

Sterling has ticked higher in response to the less-than-dovish statement. We doubt it needs to embark on a major rally, however, given that we think UK inflation will ultimately play catch-up with the disinflation trends seen in the US and the Eurozone. We think EUR/GBP can probably trace out a 0.85-0.87 range over the coming months, while a strong dollar environment can keep GBP/USD near the 1.26/27 region this quarter”.

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