Bets increase on Bank of England rate cut

The markets are preparing for aggressive US Federal Reserve moves to reduce borrowing costs. Traders have increased their bets on the Bank of England cutting interest rates this Thursday.According to LSEG, investors are pricing in a probability of around 35 percent that the UK central will cut rates 0.25 percentage points. The market had a 20 percent chance of a rate cut last week.

The BoE is expected to keep rates at 5%, but bets have increased on a reduction. Traders are increasingly expecting an jumbo Fed rate cut of 0.5 percent this Wednesday.If the Fed decides to cut rates by a half point, the recent strength of the pound — which is close to its highest value against the dollar since the year 2022 — could make it more difficult for the BOE not to do so on Thursday. A stronger pound would act as an additional brake on the economy.

Ross Yarrow is a managing director of investment bank Baird. He said that, although it was not the BoE’s mandate to follow other central banks in lowering rates, this could lead to an unwelcome increase in the pound. He said that “this would hurt the UK’s international competitiveness in exports”.

Citi economists believe UK policymakers will cut rates next week due to “soggy data on summer activities, along with continued moderated wage growth, and services inflation”. Last month, the BoE cut interest rates for more than four-years from a record high of 5,25 percent. The European Central Bank already reduced rates by two quarter points this year, but the Fed is yet to do so in this cycle.

Investors believe that the UK inflation data for August will play a major role in determining whether the BoE will cut rates this week. LSEG polled economists who expect the headline annual rate of inflation will remain at 2.2 percent.

Ranjiv Man, senior fixed income manager at AllianzGI, said: “If the UK CPI surprises on the downside tomorrow, and the Fed reduces by 50 basis point, there is a greater risk that the BoE will cut rates by 25 basis points by this week.”

In recent months, wage pressures have also decreased. Last week, data showed that the UK’s economy stagnated in July for the second month running. Economists expected a growth of 0.2%.

“The UK is facing a serious productivity issue. . . Steve Ellis, Fidelity’s global chief investment officer of fixed income, said that the UK is in a position where it needs to lower its interest rates structurally.

Most traders believe that the BoE will be limited in its rate reductions by persistent UK service inflation. This is closely monitored by policymakers. Economists expect services inflation to rise from 5.2 percent in July to 5.5% in August.

The markets are pricing just over one percentage point in cuts for the UK in March of next year. This compares to close to two percentage points in cuts for the Fed. In a 5-4 vote, the BoE voted to support last months rate reduction. Key policymakers are not preparing for another move in this month.

Andrew Bailey, the governor of the BoE, shared with the majority the view that a sustained decline in inflation was “almost baked-in” as the global price shocks dissipate.

Four MPC members, however, continued to believe that wage and service inflation remained excessive. A major shift in the economy would be needed to get a majority of MPC members to support a reduction.

Peter Schaffrik is the chief European macro-strategist at RBC Capital Markets.