We saw the Bank of England cut rates today, and the market views the statement as hawkish. Sterling is on the way up today, but how much further can it go?

Bank of England cut Rates to 4%

The Bank of England cut interest rates by 25 bps to 4% which for the first time required a second round of voting, as the central bank deals with weak growth and stubborn inflation, i.e., stagflation.

The Bank of England voted to cut rates today, but the voting panel was told to vote a second time after four members voting for a 25 basis point cut were matched up by another four members opting for interest rates to be held. The remaining policymaker – external member Alan Taylor – voted for a 50 basis point cut, prompting Governor Andrew Bailey to call a second vote for the first time in the Bank’s history. 

Taylor changed his initial vote to back a 25-basis-point cut, joining Bailey, Sarah Breeden, Dave Ramsden, and Swati Dhingra. The members to vote for interest rates to be held were Megan Greene, Clare Lombardelli, Catherine Mann and Huw Pill, who previously called for the Bank’s interest rate-cutting cycle to slow. “We have cut interest rates today, but it was a finely balanced decision,” Bailey said.

Bank of England Forward Guidance

In terms of the forward guidance, the Committee kept its previous message of “gradual and careful” easing but added a new sentence, “the timing and pace of future reductions in the restrictiveness of policy will depend on the extent to which underlying disinflationary pressures continue to ease”, further emphasising a meeting-by-meeting approach.

Another hawkish element of the minutes was the MPC’s comment saying “overall, the MPC judges that the upside risks around medium-term inflationary pressures have moved slightly higher since May.” The vote today showed the extent of disagreement at the UK central bank in terms of how to respond to signs of weak economic growth against a resurgence in inflation.

"For GBP/USD, this surprise hawkishness from the BoE cements the importance of the recent low at 1.3150 and suggests sterling can fully take advantage of dollar weakness into year-end. This could see GBP/USD pushing into the 1.36/38 area – assuming UK data does not deteriorate too dramatically in the last quarter." (Chris Turner, ING Bank.)

"We see further GBP upside in the remainder of the year. Any dips in GBPUSD heading into key US data (particularly CPI) can be good opportunities to buy." (Jayati Bharadwaj at TD Securities.) The market took the MPC as out-and-out hawkish, but...

How hawkish was the MPC? Not as Hawkish as the Market Thinks...

When they talk about a hawkish MPC, the vote was split down the middle on the first vote, so hardly a united MPC, and one member wanted a 50 bps cut! If they were that worried about inflation, why cut rates at this meeting? They could have held them if they were that worried about inflationary pressure.

On the concerns about inflation, the Bank will in our view, probably be proved wrong. There’s no reason why inflation will become more entrenched, because headline CPI is sitting above target. It relies on workers being able to get higher wages and relies on firms having sufficient pricing power. The power of households and businesses to do that has faded as the jobs market has cooled and the economy has slowed.

The Looming Budget

The UK’s autumn budget, likely in either October or November, needs to shore up extremely narrow fiscal headroom. GDP growth contractions in recent months and higher borrowing costs have squeezed headroom, so we expect taxes up in the budget, which will hit economic growth and also squeeze consumers who are already heavily pressured. We agree with this view: "Reeves’s role in the autumn will be to restore fiscal headroom, which looks on track to be negative by adopting some combination of tax hikes, spending cuts, or fiscal rule changes. Given the unpopularity of significant spending cuts both among the public and Labour backbenchers, as well as Reeves’ unwavering commitment to meeting the fiscal rules she set out last October, tax rises appear highly likely." ( STANDARD CHARTERED) The Bank of England will cut interest rates to try and help the economy but it won't work...

Also, we view the UK troubles as having no easy fix in the near future, and here is a sobering view of the state of the UK. Ray Dalio, the billionaire founder of Bridgewater Associates, warning that "the UK is in a debt doom loop," and warning signs about a debt crisis were "beginning to flash and flicker".He also warned that bond markets were too complacent about the excessive borrowing and that the risks were not fully priced in. They are not, and we have a really bad situation in the UK, which relies heavily on outside funding for the guilt market.

We see some upside for sterling in the short term, but expect over the medium term expect significant weakness.

Technical Analysis

Our view of the key technical levels to look out for on the chart below.