Pound to Dollar Rate Slumps after BoE Goes Big on Bank Rate

"The economy has continued to be subject to a succession of very large shocks, which will inevitably lead to volatility in output," - Bank of England.

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The Pound to Dollar exchange rate slumped alongside other Sterling pairs on Thursday after the Bank of England (BoE) heaped further pressure onto already embattled companies and households with its largest interest rate rise for 27 years while offering an ominous warning about the outlook for the UK economy.

Bank Rate was lifted by half a percentage point to a new post-financial crisis high of 1.75% on Thursday in the Bank of England's latest response to an inflation rate that has reached generational highs in recent months.

Economists widely expected the move but pricing in the interest rate derivatives market had it as a much more finely balanced decision as to whether the BoE would favour of a large 50 basis point increase in Bank Rate or lift it by the more typical increment of 0.25% that it has has used since December 2021.

Forecasts for inflation were raised on Thursday when the BoE said that annual price growth will likely top 13% in the final quarter before returning to the 2% target in two years time, although far more notable was the change in the bank's characterisation of how it intends to go about addressing this challenge. 

"The economy has continued to be subject to a succession of very large shocks, which will inevitably lead to volatility in output. Monetary policy will ensure that, as the adjustment to these shocks occurs, CPI inflation will return to the 2% target sustainably in the medium term," the BoE said on Thursday.

Above: Pound to Dollar rate shown at 15-minute intervals with GBP/CAD and GBP/EUR. Click image for closer inspection.

The BoE abandoned on Thursday and in the quote above what was a prior commitment to "ensure that, as this real economic adjustment occurred, it did so in a manner consistent with achieving the 2% inflation target sustainably in the medium term, while minimising undesirable volatility in output."

The bank now says that its actions in relation to inflation "will inevitably lead to volatility in output," from the economy, meaning that it intends to squeeze the domestic economy in order to offset inflation pressures emanating from overseas, which are also leading domestic firms to lift their own prices too. 

"Inflationary pressures in the United Kingdom and the rest of Europe have intensified significantly since the May Monetary Policy Report and the MPC’s previous meeting. That largely reflects a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs. As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for UK households and further increase UK CPI inflation in the near term," the Bank of England said.

"Domestic inflationary pressures are projected to remain strong over the first half of the forecast period. Firms generally report that they expect to increase their selling prices markedly, reflecting the sharp rises in their costs," it added.

The BoE said "the labour market has remained tight, with the unemployment rate at 3.8%," and that as a result wage growth is expected to rise further.

Source: Bank of England, August Monetary Policy Report. 

Wage growth is also expected to remain far below the rate of inflation, however.

The bank downgraded its growth forecasts on Thursday and said that the economy is now expected to fall into recession during the final quarter of the year with households' post-tax incomes likely to "fall sharply in 2022 and 2023," after taking into account the elevated and still-increasing levels of inflation.

In explanation of its Bank Rate decision the BoE said "The labour market remains tight, and domestic cost and price pressures are elevated. There is a risk that a longer period of externally generated price inflation will lead to more enduring domestic price and wage pressures."

The BoE also said that it's "provisionally minded" to begin selling from September some of the £875BN of government bonds acquired over the years and under its various quantitative easing programmes.

That would be a further upward pressure on financing costs for the government and all other borrowers across the economy. 

"Policy is not on a pre-set path. The Committee will, as always, consider and decide the appropriate level of Bank Rate at each meeting. The scale, pace and timing of any further changes in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures. The Committee will be particularly alert to indications of more persistent inflationary pressures, and will if necessary act forcefully in response," the BoE added on Thursday.