Pound Sterling Sold After Bank of England Decision

Image © Pound Sterling Live, Still Courtesy of Bloomberg TV.

The British Pound dipped after three members of the Monetary Policy Committee (MPC) voted to cut interest rates.

That the Bank of England would hold Bank Rate at 4.75% was never in doubt, but that three out of nine members of the MPC voted for a cut was something of a surprise.

Dhingra, Taylor and Ramsden thought it to cut interest rates owing to a slowdown in economic growth and in the face of rising inflation.

The decision casts newcomer Taylor as a bona fide 'dove' alongside Dhingra, whose default setting is to vote for rate cuts. This suggests the balance towards easier policy (faster pace of rate cuts) in the future will be finer than it once was.

But it is Ramsden’s dissent that is noteworthy says Stefan Koopman, Senior Macro Strategist at Rabobank. "Having pushed for the first cut already at the May meeting, his shift signals that the MPC advocates quicker rate cuts than the market currently prices."

For this reason, the initial reaction to the decision was a weakening of the Pound to Euro exchange rate (1.2090). The Pound to Dollar conversion pared an earlier recovery and was quoted at 1.2540 in the initial aftermath.

"We interpret this larger vote split as a signal to the market that the MPC is advocating a more rapid pace of cuts than currently priced in," says Koopman.

The selloff is relatively contained, which is understandable when we look beyond the vote composition and consider that cutting rates a day after it was reported that inflation had accelerated to 2.6% would have looked curious.

The Bank acknowledged its latest monthly survey which showed that household inflation expectations have increased recently. The same survey also revealed that the public's confidence in the Bank's ability to return inflation to 2.0% had waned.

Credibility would have been damaged by cutting at such a point in time.

Those members who voted for a cut will have relied on new Bank forecasts that GDP growth will be weaker at the end of the year than projected in the November Monetary Policy Report.

Bank economists now expect zero GDP growth in 2024 Q4, which is weaker than the 0.3% incorporated into the November Report.

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Yet, nervousness about inflation trumps all:

"A gradual approach to removing monetary policy restraint remains appropriate. Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further," read the statement.

This reads as being unchanged from the previous statement and suggests that no major shift in stance had yet emerged, with the majority of the MPC clearly resisting any desire by the doves to steer a new course.

For this reason downside to the Pound following the decision looks limited.

The Pound rallied on Tuesday after weekly earnings unexpectedly rose to 5.2% in November, which beat estimates and confirmed pay was running too high to be consistent with inflation returning sustainably to 2.0%.

However, the Bank was keen to dismiss the number as it said this measure of pay growth was prone to volatility.

This forms part of a potential shift underway at the Bank from exclusively targetting inflation to boosting the economy in an effort to underpin employment.

"The minutes suggested the committee is increasingly thinking about the implications of the recent weakness in activity and employment. For the first time in this rate cutting cycle," says Andrew Goodwin, Chief UK Economist at Oxford Economics.

He cites a new paragraph in the statement that says the MPC is willing to consider "the potential trade-off between more persistent inflationary pressures and greater weakness in output and employment".

"The apparent growing dovish front within the MPC in spite of the latest hawkish wage data potentially suggests a greater focus on slowing activity. That reinforces our dovish view on the Bank of England for next year – we expect 150bp of cuts, against market expectations for around 55bp," says Francesco Pesole, FX Strategist at ING Bank.