Bank of England set to hold interest rates again despite declining inflation

  • The UK central bank is likely to extend the pause on “Super Thursday,” in its first meeting of 2024.
  • The Bank of England could hold its restrictive bias, pushing back against early rate-cut bets.
  • BoE Governor Bailey’s words and updated forecasts set to inject volatility in the Pound Sterling.

The Bank of England (BoE) is set to hold its policy rate for a fourth meeting in a row on “Super Thursday.” It will be the United Kingdom (UK) central bank’s first policy meeting of 2024, and it is expected to set the direction for the Pound Sterling (GBP) market in the months to come.

Bank of England to hold fire as Bailey takes center stage

The Bank of England is expected to leave the benchmark interest rate unchanged at 5.25% following its policy meeting on Thursday at 12:00 GMT. It’s a so-called “Super Thursday” as the policy announcements will be accompanied by the Monetary Policy Report (MPR) and followed by Governor Andrew Bailey’s press conference at 12:30 GMT.

Markets are currently pricing in about 100 basis points (bps) of rate cuts this year, beginning in the second quarter.

The BoE is seen maintaining its restrictive stance, affirming the narrative of “higher interest rates for longer” while resisting the market’s expectation of early rate cuts. A surprise uptick in the headline annual inflation for December, escalating Middle East geopolitical tensions and the impending impact of higher borrowing costs could dissuade policymakers from leaning in favor of a dovish policy pivot, as yet.  

While testifying before the UK Treasury Select Committee (TSC) in early January, BoE Governor Andrew Bailey said “as best as we can tell from the monitoring, we have seen that shipping traffic is being affected and rerouted. That will increase shipping prices and costs. Initially, that will be an issue in the monetary policy world and then may feed through into the financial stability world.”

Meanwhile, BoE Deputy Governor Sarah Breeden said following the December policy meeting that “it’s important for the monetary policy to be restrictive for an extended period.”

Heading into the BoE’s “Super Thursday”, the UK annual inflation stands at 4.0%, having rebounded from November’s more-than-two-year low of 3.9%. Britain’s Gross Domestic Product (GDP) expanded by 0.3% in November after October’s 0.3% decline. Meanwhile, the S&P Global UK Preliminary Services PMI surged to an eight-month high of 53.80 in January from 53.40 in December. Recent data reaffirms a continued bounce in the UK economic activity, allowing the BoE to keep the borrowing costs higher for a longer period.  

The focus, however, will also be on the central bank’s updated inflation and growth forecasts, as well as Bailey’s press conference, for fresh insights on the timing of the BoE’s policy pivot. In its November MPR, the BoE Monetary Policy Committee (MPC) said it expected GDP growth to be “broadly flat” in the fourth quarter of 2023 and over coming quarters. It was most likely CPI inflation would return to the 2% target by 2025, the report said.

Previewing the BoE events, analysts at Goldman Sachs noted, “We expect the growth projections in 2025 and 2026 to be revised up. The BoE will revise down its near-term inflation forecasts because of softer consumption data and lower energy prices, with 2% CPI hit by the end of this year – and this may allow for rates to be cut by the spring.”

“We continue to expect the first 25bps cut in May, followed by 25 bps cuts every meeting until Bank Rate reaches 3.0% in May 2025. An earlier cut in March cannot be ruled out entirely, especially if the disinflation process is coupled with further deterioration in growth,” the analysts added.

How will the BoE interest rate decision impact the GBP/USD?

If the Bank of England adopts a dovish stance, in the face of downward revisions to the inflation and growth outlook, the odds for a May rate cut would spike and smash the Pound Sterling across the board. A dovish vote split could also add to the bearish bias in the GBP/USD pair. On the other hand, the pair could see a solid recovery rally should the BoE maintain its hawkish rhetoric.   

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the major and explains: “Having failed to resist above the critical 21-day Simple Moving Average (SMA) at 1.2705, GBP/USD is testing the 50-day SMA support at 1.2677. The 14-day Relative Strength Index (RSI) has breached the midline for the downside, suggesting a negative near-term outlook for the major.”

Dhwani also outlines important technical levels to trade the GBP/USD pair: “Strong support aligns at the January 17 low of 1.2595, below which a drop toward the 200-day SMA at 1.2562 cannot be ruled out. Deeper declines will open floors for a test of the 100-day SMA at 1.2467. On the upside, Pound Sterling buyers need to recapture the 21-day SMA at 1.2705 on a sustained basis for meaningful bullish traction toward the previous week’s high of 1.2775. The next upside barrier is envisioned at the 1.2800 round level.”

Interestingly, Cable is evolving within a Cup and Handle formation. The pattern points towards potential upside however a break above recent peak at 1.2820 is essential for confirmation. Once this breakout materializes, the pair could inch higher towards the high achieved last year near 1.3140.


UK gilt yields FAQs

UK Gilt Yields measure the annual return an investor can expect from holding UK government bonds, or Gilts. Like other bonds, Gilts pay interest to holders at regular intervals, the ‘coupon’, followed by the full value of the bond at maturity. The coupon is fixed but the Yield varies as it takes into account changes in the bond’s price. For example, a Gilt worth 100 Pounds Sterling might have a coupon of 5.0%. If the Gilt’s price were to fall to 98 Pounds, the coupon would still be 5.0%, but the Gilt Yield would rise to 5.102% to reflect the decline in price.

Many factors influence Gilt yields, but the main ones are interest rates, the strength of the British economy, the liquidity of the bond market and the value of the Pound Sterling. Rising inflation will generally weaken Gilt prices and lead to higher Gilt yields because Gilts are long-term investments susceptible to inflation, which erodes their value. Higher interest rates impact existing Gilt yields because newly-issued Gilts will carry a higher, more attractive coupon. Liquidity can be a risk when there is a lack of buyers or sellers due to panic or preference for riskier assets.

Probably the most important factor influencing the level of Gilt yields is interest rates. These are set by the Bank of England (BoE) to ensure price stability. Higher interest rates will raise yields and lower the price of Gilts because new Gilts issued will bear a higher, more attractive coupon, reducing demand for older Gilts, which will see a corresponding decline in price.

Inflation is a key factor affecting Gilt yields as it impacts the value of the principal received by the holder at the end of the term, as well as the relative value of the repayments. Higher inflation deteriorates the value of Gilts over time, reflected in a higher yield (lower price). The opposite is true of lower inflation. In rare cases of deflation, a Gilt may rise in price – represented by a negative yield.

Foreign holders of Gilts are exposed to exchange-rate risk since Gilts are denominated in Pound Sterling. If the currency strengthens investors will realize a higher return and vice versa if it weakens. In addition, Gilt yields are highly correlated to the Pound Sterling. This is because yields are a reflection of interest rates and interest rate expectations, a key driver of Pound Sterling. Higher interest rates, raise the coupon on newly-issued Gilts, attracting more global investors. Since they are priced in Pounds, this increases demand for Pound Sterling.