On September 21st, during its much-anticipated monetary policy meeting, the Bank of England (BoE) made a notable announcement by maintaining its key interest rate at 5.25%. This decision came as a surprise to many in the financial markets, as the prevailing expectation was a rate hike of 25 basis pointsThe BoE's determination to keep interest rates steady follows a lengthy period of aggressive increases, with 14 consecutive hikes since December 2021, totaling a substantial 515 basis points.

In its latest statement, the central bank indicated that it may need to take additional measures if inflation remains significantly above targetsTo this end, the BoE has also accelerated its quantitative tightening policy, aiming to reduce the scale of its government bond purchases by £100 billion over the next year

Advertisements

This move reflects the bank's ongoing commitment to managing inflation amid challenging economic conditions.

Following the announcement, the British pound experienced immediate declines against the US dollar, dropping by roughly 70 points, which marked its lowest level since March this yearConversely, the FTSE 100 index showed some resilience, with losses narrowing from 0.6% to 0.2% shortly after the news broke.

Over the past few months, the UK has grappled with some of the highest inflation rates within the G7 nationsWhile other major economies, including those of the European Central Bank (ECB) and the Federal Reserve, have hinted at the nearing end of their tightening cycles, the BoE has consistently emphasized its commitment to curbing rising prices.

The decision to maintain rates succeeded through a narrow 5-4 vote, contrasting with the August meeting where a 6-3 vote led to a 25 basis point increase

Advertisements

This shift in sentiment reflected a recent improvement in inflation data.

On September 20th, the UK Office for National Statistics reported that the Consumer Price Index (CPI) rose by 6.7% year-on-year in August, a decline from a previous value of 6.8% and below analysts' expectations of 7%. This figure represents the lowest inflation rate seen in 18 months.

Moreover, core CPI, which excludes food and fuel prices, dropped significantly from a previous value of 6.9% to 6.2%. Service sector inflation rates also eased from 7.4% to 6.8%. The BoE Governor, Andrew Bailey, expressed optimism about the downward trend in inflation, anticipating continued reductions.

Despite these positive signals, the UK's current inflation rate remains more than three times above the Bank's target of 2%. The BoE has suggested that this pause in monetary policy is only temporary; if inflation does not decrease as projected, the bank is prepared to take further action.

The Organisation for Economic Co-operation and Development (OECD) warned that, according to its September report, the UK is expected to have the highest inflation rate among major developed countries in the coming year. It projects UK inflation will reach 7.2% this year, up from its June estimate of 6.9% and surpassing that of France and Germany

Advertisements

However, a decline to 2.9% is anticipated in 2024, aligning with France's rate and slightly lower than Germany's 3.0%.

The prolonged cycle of interest rate hikes has increasingly constrained the UK's economic growth

The Bank of England pointed out that there are growing signs that the tightening monetary policy is impacting the labor market and overall economic momentum.

The BoE has revised its GDP growth forecast for the third quarter down from 0.4% to just 0.1%. Furthermore, potential growth for the latter half of 2023 might be lower than the previously estimated 0.25% in August.

Data from the Resolution Foundation, a UK think tank, indicates that households are experiencing one of the worst standards of living growth since the 1950s

• Companies Step Up Market Value Management Efforts
• Brokerages Boost Dividend Asset Allocation
• Retail in 2025: No Room for Myths
• The Patent Cliff Showdown of MNCs
• Why is Aux Electric Committed to the IPO Journey?

The typical income for working-age households in the 2024-2025 financial year is projected to decline by 4% compared to the 2019-2020 period.

Neil Birrell, a fund manager at Premier Miton, remarked that the pace of economic slowdown might suggest a forthcoming recessionSeveral organizations, including the British Chambers of Commerce, have also predicted that the UK economy will face even greater challenges in the latter half of the year, with potential for a technical recession early next year.

Furthermore, analysts from Capital Economics warned that the UK may already be in a recession. Most analysts agree that this suggests higher rates and persistent inflation are significantly affecting the UK's economy.

In the current landscape, markets are adjusting their expectations, with many concluding that the Bank of England's cycle of interest rate hikes is nearing its end

Traders have reduced their bets on further summits, forecasting a peak rate of 5.44%.

Overnight index swaps suggested that the likelihood of a 25 basis point rate increase by the BoE in November decreased from 81% just before the announcement to 64%.

Dominic Bunning, head of European Foreign Exchange Research at HSBC, noted that although the Bank of England will undoubtedly attempt to signal a message of "long-term high rates," history shows that once peak rates are achieved, forward rates tend to decrease significantly.

Before the announcement of the BoE's interest rate decision, the pound had already been underperforming against major currencies this month

Following the pause in rate hikes, the pound fell to a six-month low against the dollar.

While the Fed also paused rate hikes this month, dot plot projections indicate that the rate cuts anticipated for 2024 are now expected to be smaller than earlier forecasts, which has subsequently strengthened the dollar.

Strategists at Bank of America stress that the pound is likely to face difficulties in bouncing back in the near termThis is primarily due to concerns about economic growth prospects, resulting in downside risks for the pound against the dollar and several other major currencies in the G10.