Bank of England Sinks Pound Sterling after 75bp Rate Hike is Overshadowed by its Severe Economic Warnings

• Bank piles on the economic gloom
• Prompting a slide in GBP
• Forecasts longest ever UK recession
• Forecasts GBP to remain supressed
• But inflation to fall sharply in 2023

Above: File image of Bank of England Governor Andrew Bailey. Image: IMF Photo/Cory Hancock, reproduced under CC licensing.

Another Bank of England decision and another pummelling for the Pound.

The Bank of England raised Bank Rate by 75 basis points to 3.0% but sent a clear signal a move to 5.0% and above was not likely, a message that resulted in a knee-jerk sell-off in the Pound.

The decision to go 75bp came off a solid 7-2 vote by the Monetary Policy Committee (MPC) according to a statement released by the Bank, but this unusually large hike looks to be a one-off.

The Bank says further rate hikes are necessary but, crucially for FX markets, they won't be delivering as many as investors had previously expected, or thought necessary to bring inflation back towards 2.0%.

Above: GBP/EUR at 15-minute intervals. To better time your payment requirements, consider setting a free FX rate alert here.

The Pound fell sharply in response to the developments, here is why: the Bank's decision and financial calculations are built around market expectations for Bank Rate to rise to a peak of 5.25% in 2023.

Under such a scenario, the Bank's economists forecast inflation to fall back to 0% in three years, taking it well below the target of 2.0%.

Under the same scenario economic growth is projected to continue to fall throughout 2023 and into the first half of 2024, "as high energy prices and materially tighter financial conditions weigh on spending," says the Bank.

The UK economy is now forecast to contract 1.9% in 2023, a downgrade from August's projection for -1.2%, while unemployment is expected to increase to 4.9%, up from the previous estimate of 4.7%.

Chart: Bank of England.

Therefore the message the Bank is sending is this: Bank Rate does not need to rise to 5.25%, as the markets expect.

This inevitably forces the market to lower its expectations for the peak in UK interest rates, creating an automatic adjustment lower in the Pound:

The Pound to Euro exchange rate has fallen three-quarters of a percent at the time of writing to 1.1515, taking euro payment rates at high-street banks to approximately 1.1285 and those at independent payment specialists to approximately 1.1480.

The Pound to Dollar exchange rate has fallen 1.30% on the day (note the significant downward pressure following last night's Federal Reserve meeting at play here) to 1.1230, taking payment rates at UK banks to around 1.1006 and those at competitive independent payment providers to around 1.12.

The Pound has traditionally fallen following Bank of England policy updates in 2022, and November's monetary event is unlikely to prove an exception.

The dour forecasts produced by the Bank in this month's Monetary Policy Report echo those released in August: a month in which GBP/USD proceeded to fall 4.5% and GBP/EUR by 3.0%. 

If November's price action echoes that of August, courtesy of this Monetary Policy Report, holders of Sterling looking to transfer funds are in for a haircut.

The Bank's forecasts also show it expects the Sterling effective rate to remain around 5% lower than its 2020/1 average or around 25% lower than its pre-financial crisis rate for the foreseeable future.

(If you are looking to secure your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)

The Bank's forecasts show the UK has begun what will be the longest-ever recession, one that will last eight consecutive quarters, and based on its inflation forecasts, the Bank is suggesting the time to end the hiking cycle is approaching.

"The MPC's new forecasts suggest that the base case now is that the tightening cycle is nearly over," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

Chart: Bank of England

Tombs says the forecasts imply that the MPC thinks Bank Rate needs to rise by only about 50bp further in order for inflation to hit the 2% target.

With limited interest rate hikes ahead the Pound could find itself without meaningful support from the interest rate channel: higher domestic interest rates tend to attract foreign investment capital amidst a global hunt for superior returns, which in turn can support a currency.

Barret Kupelian, Senior Economist at PwC, says the Bank's economic forecasts suggest the UK will suffer a significantly worse economic performance relative to the U.S. and the Eurozone.

"More worryingly, the Bank expects no growth in labour productivity and a fall in business investment, all of which make the UK a less attractive place to do business. Precisely because of the lack of growth, the Bank expects the unemployment rate to steadily increase to just around 6.5% in three years’ time," says Kupelian.

The Bank has piled on the economic gloom and this will likely ensure expectations for recession become a self-fulfilling prophecy.

Given currencies are sensitive to relative economic performance, this bodes poorly for the Pound's outlook, both near- and long-term.