The pound fell 2% against the US dollar yesterday after the Bank of England raised interest rates up to 1% but painted a gloomy economic outlook warning about a possible recession at the end of the year. The pound sustained significant losses against the euro and the US dollar but is trying to recover ahead of the weekend.
The Bank of England’s economic forecasts published in its Monetary Policy Report shocked markets with their cautious and pessimistic tone and analysts said that the pound will remain weak for some time. Derek Halpenny, Head of Research for Global Markets EMEA at MUFG said that the outlook for the pound will be as “grim” as the GDP forecasts delivered by the BoE yesterday.
The BoE might not be the only bank that strikes a cautious tone and warns about the gloomy economic outlook, as other developed market economies face similar inflationary and growth challenges, and their central banks will also have to slow down their rate hike expectations in the coming weeks. If this does happen, the pound could begin to strengthen.
No more rate hikes?
The BoE has definitely surprised markets with some members of the Monetary Policy Committee supporting a 25bp hike but not referring to further rate hikes, suggesting that the MPC is near the end of its hiking cycle.
The BoE's growth forecasts with the 2023 GDP growth forecast being slashed by 150bp to -0.25% was perhaps the most surprising, as the MPC expects the economy to contract in 2023.
As we previously noted, the pound’s shock is linked to a difference of opinion and expectations between the Bank of England and markets. The market was pricing 8-9 more rate hikes from the BoE in the next year or so and more than 25bp hikes in the next two meetings.
Markets expect too many rate hikes, analysts warn
While the Bank said more rate hikes are possible, these won’t be as many as the market is expecting and Sterling will continue to be under pressure.
Some analysts have said that the MPC may hike one more time in the current cycle by 25bp, while others noted that it could keep rates unchanged to avoid a recession, with the risk of inflation reaching extremely high levels.
Bank of America expects three more 25bp hikes in June, August and November, while Investec’s rate expectations have been lowered to 12bps to 2-2.25%. NatWest Markets believes there will be a 25bp Bank rate hike to 1.25%, in August, followed by a pause as the MPC assesses the risks from higher energy prices and the cost-of-living crisis.
The pound will remain under pressure at least in the near-term as higher inflation risks and a waning rate hike cycle keep market sentiment weak. However, once other central banks begin expressing similar concerns as the BoE, then the pound is expected to start recovering, perhaps in a few months.
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