Bank of England bashes pound after halting rate rises

LONDON (Reuters) - The Bank of England on Thursday left interest rates unchanged, breaking a long run of rate rises as the British economy slowed, which sent the pound to a six-month low and gave London-listed stocks a brief boost.

The pound dropped by as much as 0.9% to its lowest since late March. UK government bonds briefly erased some price losses, before resuming their decline, while rate-sensitive areas of the London equity market, such as real estate shares and homebuilders, bounced.

Investors had already rushed on Wednesday to reel in their bets on further UK rate rises after data showed UK inflation cooled surprisingly quickly in August.

MARKET REACTION:

FOREX: Sterling was last down 0.7% at $1.2263, versus $1.22935 earlier in the day. Against the euro, the pound was down 0.5% at 86.74 pence, having traded around 86.70 pence before the decision.

MONEY MARKETS: Interest rate futures showed traders believe there is a 70% chance the central bank will leave rates unchanged at its next meeting in November, compared with around 50/50 before the decision. Two-year gilt yields, the most sensitive to shifts in rate expectations, briefly fell by 2 basis points on the day right after the decision. By 1215 GMT, however, yields had reversed course to trade up 8 bps at 4.92%.

STOCKS: The blue-chip FTSE 100 erased some of the day's losses to trade 0.3% down, compared with a 0.7% fall earlier on. A subindex of homebuilder shares briefly rose by as much as 3%, while an index of real estate shares rose 1.1%.

COMMENTS:

THOMAS SARTAIN, SENIOR PORTFOLIO MANAGER FOR FIXED INCOME, INVESCO, LONDON:

"Recent communication from the bank has suggested they are close to the end of the hiking cycle – such as Bank of England chief economist, Huw Pill's analogy of the path of bank rate preferring a Table Mountain approach of a long peak, rather than the Everest profile on policy (sharply up and back down again). The inflation release proved the final catalyst to press the pause button.

Looking forward, we see headwinds continuing to build for the UK economy – the labour market is clearly losing momentum and interest rate sensitive sectors of the economy are feeling the pain from higher rates."

HUGH GIMBER, GLOBAL MARKET STRATEGIST, J.P. MORGAN ASSET MANAGEMENT, LONDON:

"Despite efforts in the statement to keep the door open to further hikes, many investors will now assume that the Bank of England’s hiking cycle has concluded."

"We see two key risks to this view. In terms of the domestic picture, the recent easing in services inflation was primarily driven by seasonal factors linked to airfares and hotel prices."

"While the Bank will now be hoping that this cooling broadens to other parts of the economy, strong wage pressures stemming from structurally tight labour markets make this far from assured. The 25% rally in oil prices since midyear is another watch item, given the way that it could offset lower domestic energy prices in the months ahead."

PHILIP SHAW, CHIEF ECONOMIST, INVESTEC, LONDON:

"The MPC's decision seemed very likely to be finely balanced following the much better-than-expected CPI numbers yesterday and indeed, the vote split of 5-4 could not have been closer."

"At the end of the day, perhaps the deciding factor was that the majority of the committee chose not to place too much weight on July’s high pay numbers. We suspect that we are now at peak rates and that the MPC will begin to loosen policy in mid-2024."

DOUGLAS GRANT, GROUP CEO, MANX FINANCIAL GROUP, LONDON:

"After the unexpected and encouraging decrease in CPI inflation witnessed yesterday, an interest rate hike has also been paused, providing some reassurances for businesses and consumers alike. With small and medium enterprises (SMEs) representing approximately half of all private sector turnover in the UK, it is imperative that we devise innovative measures to safeguard their viability."

"Compared to last year when only a quarter encountered obstacles, two in five SMEs have now either halted or slowed down some aspect of their operations due to a lack of external financing."

JEREMY BATSTONE-CARR, EUROPEAN STRATEGIST, RAYMOND JAMES, FRANCE:

"Undoubtedly, the overriding factor behind the Bank's decision has been the fall in the UK's inflation rate in August, particularly the sharp drop in underlying price pressures which indicate that earlier rate increases are beginning to work."

"Moreover, the economy’s weakness in July means that activity over the third quarter has been revised downwards, below the Bank’s previous expectation. This is a clear sign that inflationary pressures, including wage pressures, will continue to abate over the autumn months."

FRANCES HAQUE, UK CHIEF ECONOMIST, SANTANDER, LONDON:

"The economic data released prior to the MPC meeting had provided mixed signals for the MPC members with Core CPI providing a large downside surprise. Although the majority view of economists and the market remained for a further rise, given comments recently made by MPC members, there was plenty of uncertainty in that view."

"The question now is firmly centred on whether this pause will remain or if another rate rise will be needed in November, only time and further economic data will tell."

JOE TUCKEY, HEAD OF FX ANALYSIS, ARGENTEX GROUP, LONDON:

"The surprise fall in headline and core inflation enabled the Bank of England to feel no further tightening is appropriate, a significant climb down from a market which was expecting up to 0.5% of further hikes in 2023 only a few weeks ago."

"A pause in rate hikes will be popular with UK consumers, not to mention the government, who have pledged to halve inflation in 2023. Inbound data will drive sterling sentiment, and Friday's PMI data will be an immediate catalyst for fresh market moves, especially versus the US dollar which looks vulnerable to a pullback."

RICHARD GARLAND, CHIEF INVESTMENT STRATEGIST AT OMNIS INVESTMENTS, LONDON:

"The Bank appears to have concluded that monetary policy is tight enough already to stem strong wage growth given weakness emerging elsewhere in the labour market, sufficient to bring inflation back to target."

"This week’s better-than-expected inflation print possibly helped with the BoE’s decision to not hike today. There were doubtless conflicting views but in the end the doves’ observation that previous tightening has still to affect the economy – already weakening – seems to have won out."

"The MPC still refers to its flexibility to react should things change, but the chances are this could be the peak in this UK interest rate cycle."

GILES COGHLAN, CHIEF MARKET ANALYST CONSULTING FOR HYCM, LONDON:

"There were a lot of moving parts for the Bank of England (BoE) to contend with going into today's decision. But, with yesterday's core print still three times higher than the BoE’s target and wage growth remaining strong, the BoE clearly wants to stamp inflation into the ground for good."

"However, there is a risk that the ‘lag effect’ on interest rate hikes means that today’s decision may not be felt for another 9 to 12 months." As such, with economic growth already faltering and core inflation remaining high, today’s hike runs the risk of over-tightening the economy and inducing a period of stagflation further down the line."

"For investors, they have been expecting the BoE to signal a lower path for rates ahead so the pound's reaction may be muted, especially after CPI miss yesterday which weakened the pound further going into today's meeting. However, the pound could slide further should the markets foresee stagflation ahead and perceive a BoE policy mistake."

(This story has been refiled to change location of Argentex group to London, not Oxfordshire, in paragraph 28)

(Reporting by EMEA Markets Team; Editing by Amanda Cooper and Dhara Ranasinghe)