The Bank of England lowers the pound after a 75bp rate hike in the shadow of its dire economic warnings

The Bank of England lowers the pound after a 75bp rate hike in the shadow of its dire economic warnings

  • Bank piles on the economic gloom
  • Causes an image in GBP
  • Forecasts UK’s longest recession ever
  • Forecasts GBP to remain depressed
  • But inflation will fall sharply in 2023

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

Another Bank of England decision and another tussle against the pound.

The Bank of England raised Bank Rate by 75 basis points to 3.0% but sent a clear signal that a move to 5.0% and above was unlikely, a message that resulted in a knee-jerk sell-off in the pound.

The decision to go 75bp came after a solid 7-2 vote by the Monetary Policy Committee (MPC), according to a statement from the bank, but this unusually large increase appears to be a one-off.

The bank says further rate hikes are necessary but, crucially for currency markets, they will not deliver as many as investors had previously expected, or thought necessary to bring inflation back to 2.0%.

GBP/EUR reacts to BoE decision

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

The pound fell sharply in response to the development, here’s why: the bank’s decisions and financial calculations are based on market expectations of Bank Rate rising to a peak of 5.25% in 2023.

Under such a scenario, the bank’s economists predict inflation will fall back to 0% in three years, taking it well below the 2.0% target.

Under the same scenario, economic growth is expected to continue to fall throughout 2023 and into the first half of 2024, “as high energy prices and significantly tighter financial conditions weigh on spending,” the bank said.

The UK economy is now forecast to shrink by 1.9% in 2023, a downgrade from the August forecast of -1.2%, while unemployment is expected to rise to 4.9%, up from the previous estimate of 4.7%.

Inflation will fall sharply next year

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 of a peak in UK interest rates, creating an automatic adjustment lower in the pound:

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

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

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

The hawkish forecasts produced by the bank in this month’s monetary policy report mirror those released in August: a month in which GBP/USD continued to fall by 4.5% and GBP/EUR by 3.0%.

If November’s price action mirrors that of August, courtesy of this monetary policy report, holders of Sterling looking to transfer money are in for a haircut.

The bank’s forecasts also show that it expects the sterling effective rate to remain around 5% below the 2020/1 average or around 25% below the pre-financial crisis rate for the foreseeable future.

(If you want to secure your international payment budget, consider securing today’s price for use in the future, or set an order for your ideal price when it’s reached, more info here.)

The bank’s forecasts show Britain has entered what will be the longest recession on record, one that will last for eight consecutive quarters, and based on its inflation forecasts, the bank suggests the time to end the hiking cycle is nearing.

“The MPC’s new forecasts suggest that the base case is now that the tightening cycle is almost over,” said Samuel Tombs, UK chief economist at Pantheon Macroeconomics.

UK GDP forecasts from the Bank of England

Chart: Bank of England

Mr Tombs says the forecasts suggest the MPC believes Bank Rate will only need to rise by around 50 basis points further for inflation to reach the 2% target.

With limited rate rises ahead, the pound may find itself without meaningful support from the yield channel: higher domestic rates tend to attract foreign investment capital amid a global hunt for superior yields, which in turn can support a currency.

Barret Kupelian, senior economist at PwC, says that the bank’s economic forecasts indicate that the UK will suffer a significantly worse economic development compared to the US and the euro area.

“More worryingly, the bank expects no growth in labor productivity and reduced 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 unemployment to rise steadily. to just around 6.5% in three years, says Kupelian.

The bank has fallen on the economic gloom and this is likely to ensure that expectations of recession become a self-fulfilling prophecy.

Given that currencies are sensitive to relative economic developments, this bodes ill for sterling’s prospects, both in the short and long term.

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