Bank of England preview: Inflation reports will determine what BoE does after this cut

The market will temporarily shift its focus away from the US on Thursday. At 12pm GMT the Bank of England will announce its latest interest rate decision. This month will also see the release of the final Monetary Policy Report for 2024, and the Governor, Andrew Bailey, will give a press conference at 1230 GMT.

The market is pricing in a 97% probability of a 25bp rate cut from the BOE on Thursday. Analysts expect the BOE to vote 7-2 in favour of the cut. However, after last week’s fiscally expansive Budget and excess volatility triggered by the US election, the future path for Bank Rate is now less clear.

Inflation reports will determine what BoE does after this cut

The OIS market is pricing in a 33% chance of a rate cut in December, this is down from a 65% chance the day before the UK’s Budget. We think that the BOE will be less willing to commit to future rate cuts at this meeting. Instead, they could steer the markets towards the upcoming inflation reports before the BOE’s 19th December meeting. October’s CPI report is released on 20th November, and the November CPI report is released on 18th December, the day before the BOE meeting. Along with wage data, we think that these CPI reports will be crucial for the BOE’s December decision, and whether or not they decide to cut interest rates.

UK budget to impact future BoE policy path

While the UK Budget will not impact these inflation reports, it does complicate the future rate path for the BOE, and the Budget has had a massive impact on UK rate expectations. After tomorrow’s cut there are less than 3 further rate cuts priced in until September 2025, with only 63bps of cuts expected. This compares with 97bps of rate cuts priced in before the Budget.

The market is assuming, probably correctly, that the recent shift in fiscal policy will numb the dovish impetus at the BOE. The MPC is expected to vote 7-2 to cut rates this week, however, going forward, some members may be less willing to vote for cuts if they see inflation building up in the pipeline as a result of the Budget.

We think that the Budget gives the BOE time to ‘normalise policy’, and it also raises the neutral rate for the UK economy. While traders and investors are desperate to hear what the BOE has to say about the neutral rate and where UK interest rates will eventually settle, we think that the BOE will avoid these questions. The swaps market is still positioned for UK rate cuts, but not at the same pace and magnitude as before. The BOE’s growth and CPI forecasts will also be scrutinized to see if they are in line with the OBR’s recent forecasts, of stronger inflation, but weaker growth in the long term.

The market outlook

The market impact from this week’s BOE meeting is less clear due to the fallout from the US election and the impact of a stronger US dollar that has weighed heavily on GBP/USD. However, a less dovish BOE could see further upward pressure on UK bond yields.

UK budget adds permanent premium to UK yields

UK bond yields surged on Tuesday, after a 10-year UK Gilt auction had a lower bid to cover ratio than usual. UK yields had been rising at a faster pace than US and European yields on Tuesday, however, the Gilt market has calmed on Wednesday as the focus shifts to the US and Treasury yields surge on the back of the Trump victory in the Presidential election. However, in the long term, we think that the Budget has added a permanent premium to UK yields, and we expect them to rise at a faster pace than our peers for the long term.

The outlook for the Pound

GBP/USD was under pressure on Wednesday after the win for Trump boosted the US dollar. We doubt that the BOE can move this pair back above $1.30 in the near term, and instead, it could trade in a narrow range below $1.30 for some time.

 We think that stronger UK Gilt yields are only somewhat GBP supportive. As you can see in the chart below, which shows GBP/USD and the UK10-year yield, the pound doesn’t have a strong relationship with UK yields. This is because UK yields are rising due to fears about the UK’s fiscal position, and not because of an improved growth outlook for the UK. Thus, GBP may struggle to regain the $1.30 level any time soon.

The market is quick to take fright at the UK’s fiscal prospects, as we saw in 2022 and after last week’s budget. This week’s BOE meeting is a test of investor demand for GBP. If the BOE’s growth forecasts are revised lower at this week’s meeting, and the BOE sounds concerned about rising levels of inflation caused by increases in fiscal spending, then the GBP could come under downward pressure, especially versus the dollar.

UK gilt yields and GBP/USD

Source: XTB and Bloomberg