Pound Slides As BOE’s Recession Warning Seen Limiting Rate Hikes

(Bloomberg) -- The pound slumped and UK bonds rallied after the Bank of England warned of a long recession as it delivered its biggest interest-rate hike since 1995.

The BOE’s grim economic outlook took the shine off a widely expected 50 basis-point interest-rate hike for pound investors. The currency fell as much as 0.7% to $1.2066, after policy makers raised interest rates to 1.75%.

While delivering its biggest rate rise in nearly 30 years, the BOE suggested it could be less forceful in raising rates in the coming months. It warned the UK is heading for more than a year of recession under the weight of soaring inflation, leading traders to pile into gilts as a haven.

“The BOE did not surprise so much with what they did but what they said,” said Tim Graf, head of EMEA macro strategy at State Street. “Forecasting a deep and lasting recession coupled with such a sharp rise in rates is a bold step,” he said, adding he favored selling the pound on any rallies.

BOE Raises Rates by Most Since 1995, Warns of Long Recession

Many analysts expect sterling will struggle to gain since weakness in the UK economy is likely to keep the BOE on a slower track of rate rises compared with the Federal Reserve and other major central banks. The Fed has hiked by 75 basis points at its last two meetings.

Graf still expects another 50 basis-point move at the BOE’s next meeting in September. That’s a view mirrored by money markets, which have trimmed bets on further rate rises this year to about 100 basis points. BOE Governor Andrew Bailey said the outlook for rates was not pre-set and all options were on the table.

“This could encourage further repricing of the BOE rate path by the markets as they come to the realization that the BOE is front loading rate hikes rather than sounding more hawkish,” said Valentin Marinov, head of G-10 currency research at Credit Agricole SA.

The prospect of the BOE holding back saw a rally in short maturity gilts, which are most sensitive to policy changes. The yield on two-year notes fell 11 basis points to 1.73%, while a part of the curve briefly inverted to reflect the chances of a recession.

UK Yield Curve Inverts in Latest Warning Over Growth Outlook

The pound has been under pressure all year, having clawed its way back from a two-year low of $1.1760 in mid-July mostly thanks to a weaker dollar. It’s still slumped more than 10% versus the greenback in 2022 as traders factor in rampant inflation, political uncertainty and post-Brexit disruptions.

“Sterling will remain on the back foot against the dollar,” said Jane Foley, a currency strategist at Rabobank. “Currency markets have wanted to see more forceful guidance on interest-rate hikes.”

(Updates throughout.)

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