GBP/USD drops to fresh one-month lows as BoE delivers dovish surprise, holds rates

• GBP/USD has dropped sharply and is down about 100 pips from pre-BoE announcement levels.
• The bank opted not to hike interest rates and seems to have pushed back against long-term rate hike pricing.
• But the bank signaled that a hike in December remains on the cards.

GBP/USD dropped sharply following a dovish surprise from the BoE. In an immediate reaction to the surprising monetary policy decision, the pair hit four-week lows under 1.3550, a near 90 pip drop from pre-BoE levels in the 1.3630s. Since the start of Governor Bailey’s press conference, GBP/USD has been extending on its losses and is now at more than one-month lows in the 1.3640s. Needless to say, GBP is the worst performing G10 currency on the day, with GBP/USD currently nursing losses of about 1.0%

The BoE’s decision not to hike rates on Thursday is likely to dampen investor expectations as to the aggressiveness of the coming BoE rate hiking cycle, which is in contrast to the market’s reaction to Wednesday’s FOMC meeting, which had a neutral effect on market expectations for rate hikes from the Fed. If anything, the risk is that the Fed might be drawn into lifting rates sooner than markets currently price, so if further divergence is seen in money market rate hike pricing between the UK and US (i.e. dovish bets upped in the UK, hawkish bets upped in the US), this could send GBP/USD back toward annual lows close to 1.3400. There isn't much by way of key support levels to prevent this.

BoE delivers dovish surprise

At 1200GMT, the Bank of England released their latest rate decision and monetary policy statement. The bank opted to hold interest rates at 0.1%, despite the fact that money markets were fully pricing in a 15bps rate hike. But the bank did say that it would probably have to start lifting interest rates “over the coming months” if the economy performed as expected, which should keep market expectations for a rate hike at the next monetary policy meeting in December alive. Only two BoE members voted to hike interest rates (MPC members Dave Ramsden and Michael Saunders), while three members voted to limit the bank’s UK government bond-buying remit to a total £875B. Given that six members voted to maintain the remit at £895B, QE purchases will continue until the end of the year.

The seven members who voted to hold rates at 0.1% expressed a desire to observe labour market developments in wake of the end of the government’s furlough scheme at the end of September – much of the official labour market data for October and beyond won’t be available until December, but a survey released by the UK Office for National Statistics showed that most workers who had still been on the government’s furlough programme at the end of September have now returned to their old jobs on the same number of hours. As a result, a large jump in the rate of unemployment seems unlikely, which should keep the BoE on course for a first rate hike in December, all going well.

The bank also released its new economic forecasts as part of its new Monetary Policy Report (MPR); GDP growth projections received a downgrade, with the UK economy now not seen reaching its pre-pandemic size until Q1 2022 as opposed to Q4 2021 (the forecast in the previous MPR). 2021 GDP growth is now seen at 7.0% and 2022 growth at 5.0% (down from 6.0% previously forecast). With regards to inflation, the bank now forecasts CPI reaching 5.0% by April 2022, mostly a reflection of higher energy costs (Ofcom raise the gas price cap in April), but then inflation is seen falling back towards the bank’s 2.0% target by the end of the three-year forecast time horizon. Some analysts have suggested that the bank’s inflation forecasts are more dovish than expected and may signal to rate markets that they are pricing in too many BoE hikes over the coming years. December 2022 Short-sterling futures (i.e. a proxy for where the BoE interest rate will be next December) jumped from 98.60 (implied 130bps of rate hikes) to around 98.80 (implied 110bps of rate hikes), a reflection of investors dialing back their expectations as to how aggressive the coming BoE hiking cycle will be.  

Governor Andrew Bailey has been speaking to the press at his usual post-meeting conference since 1230GMT, with the governor so far emphasising how inflation is likely to fall back to target in the coming years, though energy price volatility presents uncertainty, whilst hinting towards the fact that money market pricing for long-term rate hikes might be too aggressive. Bailey cautioned against views on the scale of rate hikes that would ultimately push inflation back below the bank’s 2.0% forecast.