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Sterling fell after the Bank of England left interest rates unchanged at 5.25% but issued guidance that suggested a 25 basis point rate cut was imminent.
Chances of an August cut rose after it was revealed that the decision to leave interest rates unchanged was a “delicate balance” for the three members of the Monetary Policy Committee (MPC) who voted for retention.
This information suggests that the decision to hold was close. With an August cut more likely, the GBP/EUR exchange rate fell to 1.1826 and the GBP/USD fell to 1.2690.
The pound rose on Wednesday after UK services inflation – which the bank wants to reduce before cutting interest rates – came in at a stronger-than-expected 5.7. However, the minutes of the meeting indicate that MPC members are increasingly convinced that it will continue to go down from here.
Some of those who voted to keep rates on hold felt that “the services price inflation report did not materially change the disinflationary trajectory the economy was on compared to the May report”.
“For these members, the policy decision at this meeting was delicately balanced,” the minutes of the meeting revealed.
With the prospect of an interest rate hike in August, it may be difficult for the pound to print new highs against the euro. Meanwhile, trade against the dollar will continue to be strongly influenced by the development of the US economy and interest rates.
“We stick to our view that there appears to be a lot of upside in the GBP price and we see downside risks for the currency against the USD and EUR from current levels,” says Valentin Marinov, head of FX strategy at Crédit Agricole.
However, other analysts do not think the Bank of England presents a significant headwind to the GBP’s performance.
“We still feel that the likely sustained UK rate advantage is helpful for GBP as UK data improves as real incomes slowly start to rise,” said Shahab Jalinoos, currency analyst at UBS.
Above: GBP/EUR (top) and GBP/USD during the day. Track GBP with custom alerts, learn more here.
Michael Brown, chief research strategist at Pepperston, says the August rate cut is unlikely to be a unanimous decision, with MPC hawks likely still concerned about intense earnings pressures and volatile service prices.
“More broadly, these concerns should see the pace of policy normalization after the first cut remain relatively slow, with only one more cut of 25 basis points, likely in November, which is the base case for the rest of 2024,” Brown says.
This underscores the general consensus among currency analysts that the amount of rate cuts that are due, rather than the start date of the rate cut cycle, is what really matters for the direction of FX.
“From the markets’ perspective, such a pace of easing, if achieved, would mean that BoE policy would normalize at a pace roughly equivalent to that of G10 peers, which would likely insulate the GBP from any significant medium-term headwinds, at least from a policy perspective,” says Brown .
Before the session, the probability of a cut at the August session was around 40% based on money market prices; it rose to around 60% following the meeting.
Markets see a 90% chance of two cuts by the end of the year.
“The relatively dovish stance of the BoE led to a somewhat weaker GBP after today’s session, in line with the rate market’s reaction. With two BoE rate cuts for this year supporting our call, we now see BoE risks to GBP well balanced. Before UK and French elections we remain positive on GBP,” says Kamal Sharma, FX strategist at Bank of America.