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The Bank of England is expected to cut interest rates by 50bp on Thursday to 1.50 percent, an all time record low, yet the British pound is rallying.
This bizarre price action stems from the fact that pound traders are looking beyond the rate cut and onto the BoE’s aggressive efforts to revive the struggling economy.
Furthermore a recent uptick in economic data suggests that a 50bp rate cut may not be the only option for the central bank.The BoE could also entertain the notion of a smaller quarter point rate cut following the improvements in retail sales, manufacturing and service sector PMI. Inflation also remains above the central bank’s target even though they believe that price pressures will fall sharply in the coming months.
Since 2008, the BoE has already cut interest rates by 350bp. As long as the central bank does not surprise the market with a 75bp rate cut, regardless of how much they ease, the British pound will remain the fifth lowest yielding currency in the developed world. Although interest rates have never fallen below 2 percent in the history of the BoE, they will be forced to make this historic move as there is no convincing evidence that a rebound is near. The undeniable willingness of the BoE to respond diligently to market troubles leads us to assume that a rate cut is all but certain.
Expect a lot of volatility following the BoE rate decision especially since the monetary policy statement could provide clues to how much further the central bank may lower interest rates. Given that Chancellor Darling warned that the recession was from over, we could see UK interest rates hit 1.00 percent.