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Traders stepped up their bets that the Bank of England will cut interest rates on Thursday, as markets braced for aggressive moves by the US Federal Reserve to lower borrowing costs.
Investors are now pricing in a probability of almost 40 percent that the central bank of the United Kingdom will reduce rates by 0.25 percentage points. It is compared with a probability of about 20 percent that the market attributed to a cut at the end of last week.
While keeping rates at 5 percent is still seen as the most likely outcome for the BoE, bets on a cut have increased as traders increasingly expect a jumbo Fed cut of 0.5 percentage points on Wednesday .
The recent strength of sterling – which is trading near its highest level against the dollar since 2022 – may make it harder for the BoE to avoid cutting rates on Thursday if the Fed opts for a half-point cut , since a stronger pound could act. as an additional brake on growth.
“While it is not part of the bank’s mandate, if the BoE did not follow (other central banks) with rate cuts, it could cause an unwanted appreciation of the pound,” said Ross Yarrow, chief executive of the investment bank Baird.
He added that this would “hurt the UK’s international competitiveness as an exporter”.
Citi economists said they believe UK policymakers will have to cut rates this week due to “weak summer activity data, with continued moderation in employment, wage growth and services inflation.” .
The BoE cut rates for the first time in more than four years last month from a 16-year high of 5.25 percent. The European Central Bank has already made two quarter-point rate cuts this year, but the Fed has yet to cut rates this cycle.
Investors say UK inflation data for August, which will be released on Wednesday, will also play a big role in determining whether the BoE cuts rates this week. Economists polled by LSEG expect annual headline inflation to remain at 2.2 percent.
“If the UK CPI surprises at the meeting tomorrow and the Fed cuts by 50 basis points, the risks increase that the BoE will cut rates by 25 basis points this week,” said Ranjiv Mann, senior fixed income portfolio manager in AllianzGI.
Wage pressures have also eased in recent months. Data last week showed that the UK economy stagnated for a second consecutive month in July, while economists had expected growth of 0.2 percent.
“The UK has a productivity problem and quite a serious one. . . We are in a situation where the UK needs structurally lower interest rates,” said Steve Ellis, global chief investment officer for fixed income Fidelity.
But most traders expect persistent inflation in UK services, which is being watched by politicians, will limit the pace of BoE rate cuts. The economy predicts that the inflation of services rose from 5.2 percent in July to 5.5 percent in August.
Markets are pricing in just over 1 percentage point of cuts in the UK by March next year, compared to almost 2 percentage points of cuts for the Fed.
The BoE voted only for the rate cut last month, in a five-to-four decision, and key policymakers have not prepared the ground for another move this month.
At the last meeting, BoE Governor Andrew Bailey shared the majority view that sustained declines in inflation were “almost baked” as global price shocks eased.
However, four MPC members continued to judge that services inflation and wage growth remained too strong for comfort. As a result, a big change will be needed for a majority to vote for a cut.
“There was almost no guidance indicating that they are willing to cut,” said Peter Schaffrik, chief European macro strategist at RBC Capital Markets.