BOE Dovish Shift Could Decouple UK from US Rates

Key Takeaway

• BOE's dovish shift hints at rate cuts as early as June, diverging from global hawkish trends and potentially decoupling UK rates from US influences.
• Market anticipates pound weakness and has fully priced in two 25-basis-point BOE rate cuts by December, with a third by March 2025.
• Speculation of a 50 basis point cut by year-end grows; options market shows bullish bets on the euro against the pound.

BOE's Dovish Shift

The Bank of England (BOE) has recently adjusted its stance, moving away from its previous tightening bias and hinting at potential easing measures while still maintaining a restrictive position. This shift was notably observed in February and March, with indications that interest rate cuts could begin as early as June. Bloomberg Intelligence's Huw Worthington notes that this decision is likely to be influenced by inflation rates falling to around 2% and pay data for April. Additionally, energy prices and survey signs from the British Retail Consortium support the BOE's expectation that the second quarter of 2024 will see UK price rises decelerate to about 2%.

Despite a global trend towards more hawkish central bank policies, influenced by changes in the Federal Reserve's outlook, the BOE's unique inflation dynamics and historical divergence from the Fed suggest a potential for earlier action by the BOE. The UK's limited inflationary risks from currency weakness further support this possibility. As a result, UK rates, which have shown high sensitivity to US rates, may begin to decouple if the BOE emphasizes the differences between the British and US economies, according to BI's Tanvir Sandhu.

Market Reactions and Speculations

The pound is anticipated to weaken against the dollar as market participants expect the BOE to adopt a dovish stance. This expectation stems from easing inflation, which provides the central bank with room to maneuver. Historically, the pound has strengthened following BOE rate decisions, but it experienced a decline after the March meeting due to debates on the timing of rate cuts. Bloomberg Economics predicts a rate cut in June, aligning with traders who have priced in a 45% probability of such a move. By December, money markets have fully priced in two 25-basis-point cuts, with a third cut possible by March 2025.

In the options market, there is a noticeable shift towards bullish bets on the euro against the pound, with euro-sterling risk reversals indicating a preference for euro calls over puts. This sentiment is supported by technical analysis suggesting a potential breakout against the pound. Meanwhile, UK gilt yields have fallen 15 basis points ahead of the BOE meeting, reflecting high market expectations for imminent rate cuts.

Interest Rate Cut Expectations

As the BOE meeting approaches, speculation is mounting regarding a dovish policy signal. The central bank's previous hawkish stance, mirroring the Federal Reserve's due to persistent wage inflation and core CPI figures above 4% annualized, is now under scrutiny. Market participants are anticipating a possible 50 basis point cut by year-end, with a 25 basis point reduction expected as early as August. This speculation occurs amidst a global shift towards more dovish central bank policies.

Economists at Bloomberg Intelligence suggest that the BOE's decision could lead to a closer vote on interest rate policies, potentially accelerating the timeline for a rate cut. This shift could distinguish the BOE's outlook from the Fed's, affecting the pound's position as a high-yielding currency alternative. The European Central Bank (ECB) also has a rate cut anticipated for June, which could influence future rate cut bets depending on euro-area growth.

Street Views

• Huw Worthington, Bloomberg Intelligence (Neutral on UK rates):

  "Despite recent market expectations leaning towards hawkishness, driven by changes in the Federal Reserve outlook, the BOE’s distinct inflation dynamics, history of divergence from the Fed, and limited inflationary risks from currency weakness indicate potential for BOE action ahead of the Fed."

• Tanvir Sandhu, Bloomberg Intelligence (Neutral on Gilts sensitivity to US rates):

  "UK rates have shown high sensitivity to US rates, but this may lessen if the BOE emphasizes the contrast between the British and US economies."