British Pound and the Bank of England Outlook: Analyst and Economist Views

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Sterling exchange rates fell ahead of the weekend and in the wake of August’s Bank of England (BoE) interest rate decision, which cast a pall over the outlook for the economy and prompted much commentary about the prospects of the Pound, some of which is included below.

The Pound declined widely on Friday alongside yields of many UK government bonds following on from Thursday’s interest rate rise from the Bank of England. 

The BoE lifted its Bank Rate to 1.75%, from 1.25% previously, in its largest increase since 1995 while citing concerns that domestic firms would continue to lift their own prices in response to inflation imported through energy and internationally traded goods prices.

Source: Bank of England. 

Downgrades to the BoE’s forecasts for the economy and its projection that the UK is headed for a more than year long recession garnered most of the headlines on Thursday but equally as striking was the bank’s redefining of how it views the role of interest rate policy in bringing down inflation.

“The very elevated levels of global energy and tradable goods prices, of which the United Kingdom is a net importer, will necessarily weigh further on most UK households’ real incomes and many UK companies’ profit margins. This is something monetary policy is unable to prevent. The role of monetary policy is to ensure that, as this real economic adjustment occurs, it does so in a manner consistent with achieving the 2% inflation target sustainably in the medium term, while minimising undesirable volatility in output,” minutes of the May meeting and other recent meetings had said.

The above statement was one half commitment and the other half the expression of a BoE psychology that at least appears to have fundamentally changed now that “minimising undesirable volatility in output” from the economy no longer features as part of the role adopted by the bank. 

Source: Bank of England. 

This time out the BoE said the economy remained under pressure from imported price inflation but warned that this “would inevitably lead to volatility in output,” and suggested that the bank itself is now more concerned with expectations for inflation than it is with the immediate path ahead of the economy. 

“The role of monetary policy was to ensure that, as the adjustment in the real economy occurred, CPI inflation returned to the 2% target sustainably in the medium term. Monetary policy was also acting to ensure that longer-term inflation expectations were anchored at the 2% target,” the BoE said of its interest rate decision in minutes of the August meeting on Thursday.

Thursday’s decision, losses for Sterling and declines for government bond yields came alongside a wide array of responses from analysts and economists, some of which are set out below in no particular order.

Lee Hardman, currency analyst, MUFG

“The pound was initially hit hard as the BoE’s policy update encouraged market participants to price in more rate cuts into next year and beyond. At one point the UK rate market had priced in an additional 25bps of cuts into the March 2024 3-month SONIA futures contract.” 

“The BoE is still expected to keep raising rates to a peak of just under 3.00% by early next year before starting to cut rates once inflation has peaked.”

“Market expectations for rate cuts from next year and beyond were encouraged by the BoE’s forecast for the UK economy to fall into recession from Q4 of this year which is expected to last for five quarters with GDP contracting by around 2 percentage points.” 

“Overall, the developments have not changed our bearish outlook for the pound and we still expect cable to fall back below 1.2000.”

Francesco Pesole, FX strategist, ING Group

“We were wrong with our call on sterling yesterday, where EUR/GBP rose 0.5/0.8% as the Bank of England delivered the grim news that the UK economy would contract for seven consecutive quarters from 4Q22. But the BoE policy rate could well be moving to 2.25% in September and a 150bp spread over the ECB policy rate should prove some insulation for sterling – at least against the beleaguered euro.”

Christopher Graham, economist, Standard Chartered

“MPC members are calculating that the current inflationary pressures – although largely stemming from imported commodity price increases – pose increased risks of second-order effects on wages and price expectations, especially given ongoing tightness in the labour market.”

“There was little reference to labour-market constraints weakening in the Q&A, and the monetary policy report noted that trend labour supply was “judged to be a little weaker than previously anticipated”. By itself, this outlook justifies an acceleration in the pace of monetary tightening.”

“However, with a significant economic recession looming, the BoE might be exacerbating downside risks to the economy and could send inflation significantly below target over the medium term (CPI inflation is seen falling to 0.8% by Q3-2025 in the monetary policy report).”

Andrew Goodwin, chief UK economist, Oxford Economics

“By increasing the pace of rate hikes at August's meeting, the MPC moved more explicitly to setting policy according to the risk profile, rather than being consistent with its central forecast. This suggests a higher peak for Bank Rate than we'd anticipated. We now see the policy rate rising to 2.5% in November, with risks skewed to the upside.”

“The MPC's new forecast shows the UK heading into a recession that will produce a significant degree of spare capacity. Even its forecast that assumes constant policy rates shows inflation eventually falling well below the 2% target. This suggests rate cuts are likely to be needed in 2023, by which time it should be clear that a wage-price spiral has not taken hold.”

Lee Sue Ann, economist, UOB Bank

“With the worsening in the cost-of-living crisis, we see room for only a further 50bps increase in the Bank Rate to 2.25%, before a pause thereafter. While we are not ruling out the possibility of another 50bps hike at the next meeting on 15 Sep, we are of the view that data will soften enough to see the MPC reverting to 25bps increments.”

“A major caveat to the BOE’s forecast is that the next PM will likely provide support to households through the winter. It remains to be seen if a big fiscal boost would be enough to reduce the scale of the hit to GDP. In any case, the BOE has equipped itself with complete flexibility by keeping the door open to a range of outcomes going forward.”

Thomas Flury, strategist, UBS Global Wealth Management 

“We think the 50bps hike on Thursday is insufficient to support the pound over the coming few months as it is already suffering from a renewed assertive Fed hawkishness. The BoE meeting has pushed [GBP/USD] cable down.”

“The Bank expects inflation to peak at around 13% in December. However, markets are pricing in even higher inflation until next year.”

“Uncertainty over inflation, energy supplies and the political outlook are likely to weigh on pound versus the US dollar over the coming few months. UK GDP is due for release next Friday and should confirm the negative sentiment.”

Michael Every, global strategist, Rabobank

“Central banks are pursuing silly monetary policy in the eyes of markets, where yield curves continue to invert and bond yields fall (even at the short end!) even as official interest rates rise.”

“For example, as the Bank of England hiked rates 50bps to 1.75%, the most in 27 years, 2-year gilt yields fells from 1.91% to 1.84%, with future hikes being priced out and cuts being priced in, while the 10-year yield slipped 3bps to 1.88%.”

Samuel Tombs, chief UK economist, Pantheon Macroeconomics

"All told, we judge that most Committee members think Bank Rate should rise further, but not to the extent anticipated by markets."

"We look, therefore, for a 25bp hike in Bank Rate in September, followed by a further 25bp increase to 2.25% in November, when the stance of fiscal policy should be clear."

"We then see Bank Rate being held at this above-neutral level until late 2023, when it should be beyond doubt that a wage price spiral has not formed. We then anticipate a small reduction in Bank Rate to 2.00% in late 2023, with a good chance of a further cut to 1.75% in 2024, provided fiscal policy isn't too stimulative in the run-up to the next election."

Mark McCormick, global head of FX strategy, TD Securities 

"The MPC decision isn't much of a shocker (8-1 vote and 50bp hike), matching our expectations of a "dovish" hike. That said, the comments around the growth outlook likely helped reverse some of GBP's perky price action in the run-up to the meeting."

"The BoE's dovish hikes have not done GBP any favors, reflecting anxieties about the growth outlook and the outlook for BoE hikes. However, we also note the importance of global drivers to GBP, which should continue to favor the USD in the short term.Our dashboard implies more upside in EURGBP, hinting at a retest of 0.85 [GBP/EUR: 1.1764}."

"GBP is closely linked to risk sentiment and global growth expectations. The global backdrop has to turn more decisively positive for GBP to build off recent gains. We don't think the global growth story is there yet, so BoE probably offers a good fade point ahead of tomorrow's US data. EUR also trading at a steep discount to our dashboard, suggesting a bit more upside for EURGBP."