GBP faced a sharp decline against both the EUR and the USD following the Bank of England's announcement of an end to interest rate hikes. After the news that interest rates would remain unchanged, the GBP's value dropped by 0.6 percent, settling at approximately £/$1.2270.
This decline in GBP's value was exacerbated by the Federal Reserve's recent decision to maintain its current interest rates, accompanied by hints of potential rate increases later in the year. In contrast, the Bank of England's communication indicated a lack of enthusiasm for further interest rate hikes, leading market speculators to anticipate interest rate cuts sooner than previously expected.
Unlike the Federal Reserve, which has managed market expectations by signalling its stance on rate hikes without actually implementing them, the Bank of England appeared resigned to the market's shift towards anticipating rate cuts. This marked a departure from its previous stance and sent a clear signal that a rate cut was on the horizon.
It's important to note that this belief may be premature, given the persistently high levels of inflation in the UK and the tight labour market. Nevertheless, this shift underscores the Bank of England's inclination towards a more "dovish" monetary policy, which typically weakens the value of the Pound.
Throughout 2023, currency markets had been bullish on GBP as the Bank of England had been raising interest rates and increasing the yield on UK bonds, providing the currency with a competitive advantage. However, this advantage is expected to wane as investors anticipate forthcoming rate cuts, putting downward pressure on the Pound's value.
The conclusion of the interest rate hike cycle may ultimately benefit the UK's economic outlook, especially if the Bank's prediction of inflation returning to the 2.0 percent target within the next three years holds true. With the Bank Rate now lower than market expectations for much of the past year, financial conditions in the UK are expected to become more accommodating for households and businesses, potentially supporting economic growth.
In the short term, however, economic data is showing negative surprises, and it may take some time for positive surprises to emerge, leaving room for further weakening of GBP. Nonetheless, if the currency market begins to reward economic outperformance, as suggested by some analysts, this could provide support for GBP in the medium term.
