The pound fell as the Bank of England (BoE) Governor Andrew Bailey stressed that the interest rate hiking cycle was now close to an end. Also, weighing on the pound to US dollar pair, was data from the US showing business activity has picked up, which has increased Federal Reserve hike expectations. The pound slumped sharply against the US dollar (USD) and is set to fall further amid increasing risk-aversion and policy divergence between the BoE and the Federal Reserve (Fed).
Bank of England dovish remarks weigh on the pound
Bank of England policymaker Swati Dhingra said on Wednesday that the current interest rate policy is sufficiently restrictive and further rate hikes would add more pressure on the economic outlook. The latest survey data has shown that the services sector has been impacted by a decline in consumer spending and deteriorating demand. The UK services PMI, which measures business activity in the sector, contracted in August for the first time since January.
Bank of England Governor Andrew Bailey appeared before members of Parliament and said the Bank of England was “much nearer now to the top of the cycle”, which indicates that he believes the peak in interest rates is close. He said: “I’m not saying we’re at the top because we’ve got a meeting to come, but I think we are much nearer to it on interest rates on the basis of the current evidence.” His comments have confirmed market expectations that a 25 basis point interest rate hike in September could be the final hike of the current hiking cycle. His remarks cast doubt on whether a November rate hike will follow that of September. The pound has weakened as markets adjust their waning expectations.About the inflation outlook, Bailey said that inflation will continue to fall as many of the indicators are moving in the right direction.
Sticky inflation could delay rate cuts
With the UK having the highest headline inflation rate in the developed world, the Bank of England is likely to keep interest rates at high levels for an extended period of time. Andrew Goodwin, Chief UK Economist at Oxford Economics said that “We expect sticky inflation will delay the first rate cut until the summer of 2024, months later than the Fed and ECB.” He added: “High wage growth means that the Bank of England is likely to maintain a restrictive monetary policy stance.”
Higher interest rates have hit spending
Higher interest rates are starting to have an impact as they have hit spending and confidence from both households and corporations in the UK. Due to higher borrowing costs, subdued business confidence, and limited household finances customer spending fell during August. Analysts have said that the BoE’s reluctance to hike rates further may be a good thing as it may safeguard the economic outlook from further vulnerability. At the same time, it could lead to higher inflation, which will further squeeze households’ real incomes.
Following Andrew Bailey’s remarks on interest rates, and with rising interest rates by Western central banks, the market mood remains cautious and uncertainty heightened. In the meantime, the US dollar has strengthened and is more attractive to investors as recession fears in the US economy have faded.