The British pound (GBP) lost half a percent against the U.S. dollar on Thursday after the country’s central bank decided not to raise its benchmark interest rates by 25 basis points.
The Monetary Policy Committee (MPC) of the Bank of England (BoE) voted by a narrow margin of 5-4 to keep the Bank Rate at 5.25%. Four members of the committee voted to raise rates to 5.5%. This decision marks the first time since December 2021 that the Bank of England has not increased interest rates.
The GBP/USD fell nearly 0.6% on Thursday to dip below the 1.23 mark. This major currency pair has been trading in a clear downtrend in recent weeks after hitting a 15-month high back in July. The pound has lost nearly 7% in about 2 months, mostly due to the greenback’s strength.
More importantly, GBP/USD now trades below important technical levels, which may invite more weakness. On the downside, the next cluster of important support levels is located in the range of 1.19-1.21. On the upside, a potential recovery above 1.25 would mean that the downtrend has likely ended.
BoE Decision
The MPC unanimously decided to reduce the stock of UK government bond purchases held for monetary policy purposes by £100 billion over the next twelve months, bringing the total to £658 billion.
“There are increasing signs of some impact of tighter monetary policy on the labor market and on momentum in the real economy more generally. Given the significant increase in Bank Rate since the start of this tightening cycle, the current monetary policy stance is restrictive,” BoE said in a statement.
The statement also noted that “there have been some further signs of a loosening in the labor market,” although it still remains tight by historical standards.
The central bank also reduced its forecast for economic growth in the third-quarter period to just 0.1%, down from the previous forecast of 0.4%. Weakness in the housing market was noted as a clear sign of economic weakness.
While there has been a notable growth in workers’ pay, the BoE expressed concerns that this growth was not supported by other labor market indicators, suggesting that policymakers anticipate it to slow down soon.
Despite the pause, the MPC reiterated its message that it was prepared to raise borrowing costs again if needed.
“Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures,” the statement added.
The Rise in Prices Slows Down
The central bank also reiterated its previous stance that monetary policy would be “sufficiently restrictive for sufficiently long” to get inflation back to its 2% target. In August, the UK CPI rose 6.7% year-over-year, much slower than the expected 7% increase. On a monthly basis, the CPI increased by 0.3%, which was below the expectations of economists who had anticipated a 0.7% month-on-month rise.
“The largest downward contributions to the monthly change in both CPIH and CPI annual rates came from food, where prices rose by less in August 2023 than a year ago, and accommodation services, where prices can be volatile and fell in August 2023,” the Office for National Statistics said in a press release.
The core CPI, which excludes volatile food, energy, alcohol, and tobacco prices, stood at 6.2% for the 12 months ending in August, marking a decrease from 6.9% in July. The goods rate increased slightly from 6.1% to 6.3%, but this increase was more than offset by a significant slowdown in the services rate, which decreased from 7.4% to 6.8%.
Following yesterday’s release of the latest inflation figures, the market pricing for a pause in interest rate hikes by the Bank of England increased significantly, rising from 20% to nearly 50%. Hence, investors were pretty much undecided on whether the BoE will hike or not as inflation seems to be slowing down faster than previously anticipated.
The BoE highlighted in its Thursday statement that the CPI fell 0.4% below expectations at the time of the Committee’s previous meeting. The CPI print triggered the exchange of open letters between the Governor and the Chancellor of the Exchequer in the context of the latest inflation figures.
According to regulation in the UK, if inflation deviates by more than 1 percentage point from the target in either direction, the Governor of the Bank of England is obligated to send an open letter to the Chancellor of the Exchequer, explaining the reasons for the deviation from the inflation target. The Governor is also required to outline the measures the BoE is implementing to return inflation to the target level.
“Since my previous letter, sent in June, there have been increasing signs that the restrictive stance of monetary policy is working to bring inflation down. This is good news,” Governor Andrew Bailey wrote in a letter.
“I can assure you that the MPC will stay the course and keep monetary policy sufficiently restrictive for sufficiently long to return inflation to the 2% target in the medium term – in line with the primacy of price stability in the Government’s monetary policy objective described in the MPC’s remit. Low and stable inflation is the foundation of a healthy economy.”
Summary
The Bank of England decided today to halt its streak of 14 consecutive interest rate hikes in response to new data indicating that inflation is rising slower than expected. Following this decision, the British pound fell by 0.5% against the U.S. dollar, hitting a fresh 6-month low.
