Warnings of a Negative Shock That Would "Sink" Pound Sterling Against Euro and Dollar

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The British Pound "could be in for a negative shock if the Bank of England cuts interest rates at its next two meetings," according to a new analysis.

The call by Robert Howard, market analyst at Reuters, comes ahead of Wednesday's important UK inflation print which is expected to firm the likelihood of a summer interest rate cut.

Markets are already fully priced by a cut being delivered by August, but upping expectations for two consecutive cuts would require a significant market recalibration that would weigh notably on Pound exchange rates.

"Back–to–back BoE cuts would pull the rug from under GBP," says Howard, who warns the Pound to Dollar could fall as far as 1.23 under such circumstances.

If EUR/USD remains steady under such a scenario, the Pound to Euro exchange rate could dip as far as 1.15.

"The received wisdom is that the BoE will reduce rates on either June 20 or August 01 – but not on both dates," explains Howard.

He says if June sees a cut, it will probably be delivered by the narrowest of margins, 5-4, with Andrew Bailey, Ben Broadbent and Sarah Breeden most likely to join Dave Ramsden and Swati Dhingra in voting for it.

Broadbent said on May 20 that the Bank would cut interest rates this summer if the Bank's forecasts simply met expectations, which implies something of a low bar to cross.

"Should that come to pass, a follow-up cut in August is by no means impossible, given last week's relatively dovish comments from BoE Chief Economist Huw Pill and hawk Megan Greene," says Howard.

August will also see Clare Lombardelli cast her first Monetary Policy Committee rate vote as she joins the MPC, having succeeded the outgoing Broadbent.

"Unlike the U.S., UK inflation in recent quarters has undershot the central bank's expectations and is likely to return to target in the next month or two," says Michael Saunders, Senior Economic Advisor to Oxford Economics and a former member of the Bank's Monetary Policy Committee.

"We expect the BoE will start to cut rates in June or August, with June marginally the more likely, but this will depend on upcoming pay and price data," he adds.

Yet, some analysts warn there is a risk services inflation will deliver another upside surprise on Wednesday, which could scare a number of MPC members into voting to hold rates next month.

This means a strong services inflation print would scupper risks of back-to-back rate cuts as August emerges as the favoured start date, bolstering Pound exchange rates in the process.

"We think services inflation could come in hotter than expected, and if we're right, that would favour another 'on hold' decision next month," says James Smith, Developed Markets Economist at ING Bank.

Services inflation is the aspect of the inflation basket that has proven resilient and might ultimately undermine a sustained fall in the headline rate to fall to 2.0%. It is why the Bank won't see a 2.1% reading in headline CPI as proof of victory over inflation and an automatic trigger to lower interest rates.

But, a sharp deceleration in services inflation could well raise the risks of a June start and consecutive August cut, which will weigh on the Pound.