BOE Rate Cut Speculation Amid Global Caution, Sterling Waits

Key Takeaway

• Market participants await BOE's rate cut signal, with speculation on timing and comparison to Fed's actions amid reduced post-Covid currency sensitivity.
• BOE maintains a cautious stance due to temporary inflation dip expectations and high services/core inflation, limiting immediate easing scope.
• Sterling shows resilience but faces pressure from potential dovish BOE shifts; central banks globally adopt cautious rate adjustment approaches.

BOE Rate Cut Speculation

As the Bank of England (BOE) convenes, market participants are closely monitoring for any indications of an impending interest rate cut, though immediate expectations have been tempered. The central focus is on discerning the timing of the BOE's first rate reduction and whether it will precede any similar action by the Federal Reserve. Historically, central banks from developed nations have been cautious about preempting the Fed due to potential adverse effects on their currencies. However, recent analysis by Deutsche Bank suggests that the pound's sensitivity to BOE-Fed policy divergence has diminished post-Covid, with consequential impacts on inflation also significantly reduced. UBS economist Dean Turner has downplayed the necessity for non-US central banks to delay their actions until after the Fed, citing minimal impact on inflation forecasts from exchange rate fluctuations. Despite these insights, the Swedish krona and Swiss franc have experienced declines following their respective central banks' rate cuts, highlighting the nuanced relationship between central bank decisions and currency valuations.

Inflation and Monetary Policy Dynamics

The BOE's cautious stance on rate adjustments is underscored by its projection of a temporary dip in headline inflation to the 2% target in the second quarter, followed by an expected acceleration. This outlook suggests a preference within the BOE to observe further inflation trends before committing to a rate cut. Governor Andrew Bailey's recent dovish comments about the economy "disinflating at full employment" contrast with the ongoing high levels of services inflation and a core inflation gauge above 4%, limiting the BOE's immediate scope for easing. The financial community is particularly attentive to any potential shifts in the BOE's language from its March statement, which emphasized the necessity of maintaining a restrictive monetary policy to sustainably achieve the 2% inflation target.

Sterling's Position and Market Reactions

The pound's resilience is notable, having declined nearly 2% against the dollar this year, yet it remains robust among G-10 currencies amidst a generally strong dollar. This resilience may be tested if the BOE adopts a dovish stance in its forthcoming announcements. Sterling credit returns have underperformed relative to euros, with a 2.15% loss in April due to uncertainties around the BOE's rate cut trajectory, contrasting with a brief positive return in March. This performance highlights the challenges facing sterling assets in the current economic climate.

Comparative Central Bank Strategies

The BOE's cautious approach to rate cuts is mirrored by other central banks, including the European Central Bank (ECB) and the Federal Reserve, which also exhibit a reluctance to commit to rate adjustments without further economic data. This strategy aligns with the Reserve Bank of Australia and the Fed's preference for data-driven decision-making. The movement of the EUR/GBP pair will likely depend on the BOE's ability to clearly signal its easing intentions, particularly in light of the ECB's anticipated cut in June.

Street Views

• Deutsche Bank Economists (Neutral on the sensitivity of sterling to BOE-Fed policy divergence):

  "The sensitivity of sterling to diverging BOE-Fed policy has reduced since Covid, with the knock-on effects on inflation also shrinking dramatically."

• Dean Turner, UBS Economist (Neutral on non-US central banks waiting for the Fed):

  "Any related exchange rate moves would have to be large to add more than a ‘rounding error’ to central banks’ inflation forecasts."