Bank of England bashes pound after pausing rate rises
Bank of England bashes pound after pausing rate rises
Bank of England Holds Interest Rates, Pound Falls to Six-Month Low
Image source: Reuters
London, Sept 21 (ANBLE) – In an unexpected move, the Bank of England (BoE) decided to leave interest rates unchanged, breaking a long series of rate increases as the British economy showed signs of slowing down. The decision caused the pound to plummet to its lowest level in six months, while giving a temporary boost to London-listed stocks.
The pound experienced a drop of up to 0.9%, reaching its lowest point since late March. However, UK government bonds briefly recovered from price losses before continuing their decline. Rate-sensitive areas of the London equity market, such as real estate shares and homebuilders, also saw a brief bounce.
Investors had already reacted the day before by pulling back on their bets for additional rate increases in the UK, after data revealed a surprising cooling of UK inflation in August.
Market Reaction
The reaction in the forex market saw the pound down 0.7% at $1.2263, compared to $1.22935 earlier in the day. Against the euro, the pound was down 0.5% at 86.74 pence, after trading around 86.70 pence prior to the BoE’s decision.
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Interest rate futures indicated that traders believe there is a 70% chance that the central bank will maintain rates at their current level in its next meeting in November, compared to a roughly 50/50 chance before the decision. The two-year gilt yields, which are the most sensitive to changes in rate expectations, briefly dropped 2 basis points immediately after the decision. However, by 1215 GMT, yields had reversed course and were up 8 bps at 4.92%.
On the stock front, the blue-chip FTSE 100 erased some of its earlier losses and traded down only 0.3%, compared to a 0.7% fall earlier in the day. A subindex of homebuilder shares briefly rose by as much as 3%, while an index of real estate shares increased by 1.1%.
Expert Comments and Analysis
Thomas Sartain, Senior Portfolio Manager for Fixed Income at Invesco, London, noted, “Recent communication from the bank has suggested they are close to the end of the hiking cycle – such as Bank of England chief, Huw Pill’s analogy of the path of bank rate preferring a Table Mountain approach of a long peak, rather than the Everest profile on policy. The inflation release proved the final catalyst to press the pause button.”
Hugh Gimber, Global Market Strategist at J.P. Morgan Asset Management, London, stated, “Despite efforts in the statement to keep the door open to further hikes, many investors will now assume that the Bank of England’s hiking cycle has concluded.”
He further added, “We see two key risks to this view. In terms of the domestic picture, the recent easing in services inflation was primarily driven by seasonal factors linked to airfares and hotel prices. While the Bank will now be hoping that this cooling broadens to other parts of the economy, strong wage pressures stemming from structurally tight labor markets make this far from assured. The 25% rally in oil prices since midyear is another watch item, given the way that it could offset lower domestic energy prices in the months ahead.”
Philip Shaw, Chief Economist at Investec, London, commented on the decision, stating, “The MPC’s decision seemed very likely to be finely balanced following the much better-than-expected CPI numbers yesterday and indeed, the vote split of 5-4 could not have been closer.” He further added, “At the end of the day, perhaps the deciding factor was that the majority of the committee chose not to place too much weight on July’s high pay numbers. We suspect that we are now at peak rates and that the MPC will begin to loosen policy in mid-2024.”
Douglas Grant, Group CEO of Manx Financial Group, London, expressed his opinion on the decision, saying, “After the unexpected and encouraging decrease in CPI inflation witnessed yesterday, an interest rate hike has also been paused, providing some reassurance for businesses and consumers alike. With small and medium enterprises (SMEs) representing approximately half of all private sector turnover in the UK, it is imperative that we devise innovative measures to safeguard their viability.”
Furthermore, Grant noted, “Compared to last year when only a quarter encountered obstacles, two in five SMEs have now either halted or slowed down some aspect of their operations due to a lack of external financing.”
Other experts also shared their insights. Jeremy Batstone-Carr, European Strategist at Raymond James, France, stated, “Undoubtedly, the overriding factor behind the Bank’s decision has been the fall in the UK’s inflation rate in August, particularly the sharp drop in underlying price pressures which indicate that earlier rate increases are beginning to work.” He added, “Moreover, the economy’s weakness in July means that activity over the third quarter has been revised downwards, below the Bank’s previous expectation. This is a clear sign that inflationary pressures, including wage pressures, will continue to abate over the autumn months.”
Frances Haque, UK Chief Economist at Santander, London, highlighted the mixed signals provided by economic data prior to the MPC meeting. She commented, “The economic data released prior to the MPC meeting had provided mixed signals for the MPC members with Core CPI providing a large downside surprise. Although the majority view of economists and the market remained for a further rate rise, given comments recently made by MPC members, there was plenty of uncertainty in that view.” She added, “The question now is firmly centered on whether this pause will remain or if another rate rise will be needed in November, only time and further economic data will tell.”
Joe Tuckey, Head of FX Analysis at Argentex Group, Oxfordshire, noted the significance of the fall in inflation, stating, “The surprise fall in headline and core inflation enabled the Bank of England to feel that no further tightening is appropriate, a significant climb down from a market which was expecting up to 0.5% of further hikes in 2023 only a few weeks ago.” He further added, “A pause in rate hikes will be popular with UK consumers, not to mention the government, who have pledged to halve inflation in 2023. Inbound data will drive sterling sentiment, and Friday’s PMI data will be an immediate catalyst for fresh market moves, especially versus the US dollar which looks vulnerable to a pullback.”
Richard Garland, Chief Investment Strategist at Omnis Investments, London, highlighted the reasoning behind the BoE’s decision, stating, “The Bank appears to have concluded that monetary policy is tight enough already to stem strong wage growth given weakness emerging elsewhere in the labor market, sufficient to bring inflation back to target.” He added, “This week’s better-than-expected inflation print possibly helped with the BoE’s decision to not hike today. There were doubtless conflicting views, but in the end, the doves’ observation that previous tightening has still to affect the economy – already weakening – seems to have won out.” Garland concluded, “The MPC still refers to its flexibility to react should things change, but the chances are this could be the peak in this UK interest rate cycle.”
Giles Coghlan, Chief Market Analyst Consulting for HYCM, London, noted the complexity of the decision, saying, “There were a lot of moving parts for the Bank of England (BoE) to contend with going into today’s decision. But, with yesterday’s core print still three times higher than the BoE’s target and wage growth remaining strong, the BoE clearly wants to stamp inflation into the ground for good.”
Coghlan also mentioned the potential risks, stating, “However, there is a risk that the ‘lag effect’ on interest rate hikes means that today’s decision may not be felt for another 9 to 12 months.” He further added, “With economic growth already faltering and core inflation remaining high, today’s hike runs the risk of overtightening the economy and inducing a period of stagflation further down the line.” He concluded, “For investors, they have been expecting the BoE to signal a lower path for rates ahead, so the pound’s reaction may be muted, especially after the CPI miss yesterday, which further weakened the pound going into today’s meeting. However, the pound could slide further should the markets foresee stagflation ahead and perceive a BoE policy mistake.”
In summary, the Bank of England’s decision to hold interest rates surprised the market and caused the pound to slump to a six-month low. Various experts have provided their analysis, highlighting factors such as a decline in inflation, signs of weakening economic growth, and strong wage pressures. The decision not to hike rates may bring short-term relief for businesses and consumers, but its long-term impact remains uncertain as the economy continues to face challenges.
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