Thursday brought a challenging outlook for UK assets as the Bank of England (BoE) presented a set of forecasts that painted a bleak picture, leading to the sterling’s most significant one-day drop in four weeks. The currency’s decline came despite bond yields remaining largely stable.
The BoE announced a reduction in interest rates to 4.5% and slashed its growth forecast for the year to 0.75%, a significant decrease from previous estimates. Inflation expectations were also adjusted, with projections indicating a sharp increase to peak at 3.7% within the year, surpassing earlier predictions.
Premier Miton Investors’ CIO Neil Birrell expressed concerns over the potential for ‘stagflation’, a state characterized by high inflation coupled with stagnant economic growth. However, BoE Governor Andrew Bailey dismissed the notion that the UK was experiencing stagflation, asserting that underlying inflation was on a downward trajectory.
In response to the central bank’s forecasts and rate decision, the sterling weakened, trading about 0.8% lower at $1.241, marking its largest daily fall since January 10. This decline occurred despite the currency reaching a four-week high the previous day.
Investors reacted by increasing their bets on further interest rate cuts, with expectations now set for approximately 66 basis points of easing this year, up from 60 basis points anticipated prior to the BoE’s announcement.
The bond market appeared to be supported by this backdrop, especially after enduring a rough start to the year. Two-year bond yields, which are particularly sensitive to rate expectations, briefly dropped to their lowest point since October, contrasting with steadier yields in the U.S. and Europe. Conversely, longer-term yields for 10 and 30-year bonds experienced a slight uptick.
The BoE’s latest meeting revealed a split within the Monetary Policy Committee (MPC), with two members advocating for a more substantial 50 basis point cut in rates. This included Catherine Mann, who had previously voted to maintain steady rates. The UK economy has shown minimal growth since mid-2024, and recent data has prompted policymakers to adopt a more aggressive stance, according to Paul Jackson of Invesco.
Despite the immediate reaction in currency markets to the BoE’s decision, some analysts, like Nick Rees from Monex Europe, believe the move in gilts is a more accurate reflection of the situation than the volatile FX markets.
The FTSE 100 index in London surged to a record high, closing up 1.5%, buoyed by robust earnings reports and the falling pound, which tends to benefit the index’s export-heavy constituents. Additionally, UK homebuilding stocks reached their highest point in over 12 weeks, as lower interest rates favor the sector.
Invesco’s Jackson remains optimistic about UK equities and government bonds in light of the BoE’s actions. However, global trade tensions persist as a concern, with recent tariff threats by U.S. President Donald Trump against Mexico and Canada likely to impede growth, though these potential impacts are not yet factored into official forecasts.
