Pound on a 'Softer Footing' after Bank of England Turns Cautious say Analysts

  • GBP/EUR back below 1.19
  • But GBP/USD steady post Fed
  • "The GBP sell off reflects initial disappointment" - MUFG
  • BoE dampens future rate hike expectations
  • Peak hawkishness towards BoE has passed

Bank of England

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The near-term outlook for Pound Sterling has softened say analysts as they react to the Bank of England's signal that the market is expecting more interest rate hikes than it is willing to give.

The Bank's Monetary Policy Committee (MPC) on Thursday voted 8-1 to hike rates by 25 basis points, but at the same time issued a cautious set of guidance regarding the need for further interest rate rises.

The Bank said further hikes were needed but cautioned the market's expectation for Bank Rate to be at 2.0% by year-end was extreme, sending interest rate markets and Sterling exchange rates lower as investors recalibrated.

The UK currency was sold against all its major peers in response to an apparent mismatch between what the market was looking for and what the Bank actually intends to deliver.

"The GBP sell off reflects initial disappointment amongst market participants that the BoE’s policy update was not as hawkish as expected," says currency analyst Lee Hardman at MUFG.

GBP to EUR four hour

Above: GBP/EUR four-hour chart.

  • Reference rates at article's last update:
    GBP/EUR: 1.1877 \ GBP/USD: 1.3164
  • High street bank rates (indicative): 1.1544 \ 1.2795
  • Payment specialist rates (indicative): 1.1794 \ 1.3090
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Ahead of the decision the market was pricing in a further 134 basis points of hikes for 2022 as the Bank steps forward to fight surging inflation, but by Friday morning this had been reduced to 123 points.

The Bank is now clearly concerned that the war in Ukraine will pour fuel on an inflationary fire that is consuming the purchasing power of individuals and companies alike, threatening the economy's health.

Energy, food and other commodity prices have surged further since Russia's invasion of its neighbour which means inflation will increase further in coming months, to around 8% in the second quarter according to the Bank's projections, "and perhaps even higher later this year".

The Bank said there were limits to the measures it could take to tackle such imported inflation.

In fact it said it sees inflation destroying demand to the extent that over the medium-term inflation falls back faster than it had forecast at previous rate meetings.

This suggests the Bank sees little benefit in hiking interest rates too aggressively when inflation will burn itself out.

"It has prompted a paring back of BoE rate hike expectations," says Hardman.

The Pound to Euro exchange rate fell back below 1.19 in as markets pared expectations and now threatens a test below 1.18.

But the Pound to Dollar exchange rate defended 1.31 as the Dollar in fact proved to be the day's biggest loser in the wake of the Federal Reserve's policy meeting which was held some hours prior.

"No one can accuse the BoE of rushing it, but even the recent tempo of hikes looks too quick. Thus the pound has seen its gains against various currencies given back, and could struggle in the near-term as the more dovish tone is digested by markets,” says Chris Beauchamp, chief market analyst at IG.

GBP to USD four hour chart

Above: GBP/USD at four-hour intervals.

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Beauchamp says it looks to him like the Bank is going for a pause in its hiking path, having pushed on ahead of other central banks with its third hike in as many meetings. "The likely slowdown in the UK economy means that, even if inflation continues to rise, the bank may look to act in an even more measured manner".

Money markets have adjusted in the wake of the Bank's message and have scaled back expectations for a larger 50bps hikes being delivered at upcoming policy meetings heading into the summer.

In the aftermath of the decision rates markets now expect the Bank to deliver four more 25bps hikes at consecutive meetings up until September with another in early 2023.

The Bank stated the need for modest tightening "may be appropriate" in the coming months.

But in February it said some further modest tightening was "likely to be appropriate".

"The BoE’s less hawkish policy update today argues in favour of the GBP continuing to trade on a softer footing in the near-term," says Hardman.

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Hardman says if the conflict proves more prolonged downside risks for the Sterling will continue to build and put Pound-Dollar on course to retest and break below the 1.3000-level.

"A clear de-escalation of the Ukraine conflict will be required for the GBP to stage a more sustained rebound," he adds.

Kamal Sharma, FX Strategist at Bank of America says UK rate hikes will not provide a boost to the Pound going forward.

"Simply put, the Bank of England is hiking in our view, for the wrong reasons and sounding defensive," says Sharma. "The MPC sounded almost apologetic about hiking once more."

Sharma says the Bank is in a position of weakness where it is "hiking due to supply shocks (one of which - Brexit - it still fails to acknowledge) against the backdrop of a generational squeeze in personal incomes."