How Long Does the BOE Plan to Keep Rates on Hold for “Extended” Period?

After declining throughout most of September, the GBP has spent the past month consolidating at lower levels. Following the release of weaker nonfarm payrolls last Friday, Cable attempted to break higher but failed to surpass resistance from the 200-day moving average at around 1.2435. Conversely, EUR/GBP has been trying to move higher but is currently struggling to extend its advance beyond 0.8700-0.8750, having climbed above the resistance from the 200-day moving average at around 0.8690 on October 19th.

The GBP's performance this year closely tracks short-term yield differentials. In the first half of the year, the GBP outperformed other G10 currencies, strengthening by 5.1% against the USD and 3.2% against the EUR. This surge was driven by the hawkish repricing of BoE rate hike expectations between March and June. However, in early July, these expectations peaked, and market participants have since been reducing them. The BoE's recent policy update in the early part of this month reinforced the belief that the 0.25-point hike in September marked the end of the current tightening cycle. While the possibility of further hikes was not ruled out, the updated forward guidance emphasized maintaining restrictive rates for an "extended period of time."

With the BoE signalling that its rate hike cycle has peaked, attention is turning to when the central bank might begin to reverse its policy tightening. BoE Chief Economist Huw Pill suggested that leaving rates on hold for the first half of this year and potentially cutting rates from the second half of next year could be a plausible scenario. The market is currently pricing in approximately 16 bps of BoE rate cuts by the June MPC meeting and 25 bps by the August MPC meeting.

The recent loss of cyclical momentum in the UK economy and slowing inflation are alleviating pressure on the BoE to further raise rates. The BoE's latest Quarterly Inflation Report revised down GDP forecasts, indicating stagnation through the end of next year. The UK GDP report for Q3 showed flat growth, with weak domestic demand, a decline in private consumption by -0.4% Q/Q, and business capex by -4.2% Q/Q.

The upcoming release of the UK CPI report for October is expected to provide more evidence of a sharper slowdown in inflation. The BoE anticipates a fall in the headline inflation rate to just under 5.0% in October, driven by lower energy prices and the exclusion of the OFGEM price cap increase of 80% in October 2022 from the CPI annual calculation. Food price inflation is also expected to ease from 12.1% in September to around 9% in Q4.

Despite these developments, the BoE remains focused on core and services inflation, where upward pressures may not have eased significantly. Services inflation has slowed, but the BoE is cautious about its sustainability. The BoE continues to express concerns about persistent inflation risks, downgrading its growth forecast for the supply side of the economy.

Given these circumstances, the expectation is for the GBP to weaken further as the UK rate market factors in more BoE cuts into the next year (currently around 60 bps of cuts priced by December 2024). However, a more substantial decline may require additional evidence of slowing UK inflation and a softening labour market in the coming week.

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