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The British Pound fell after the Bank of England cut interest rates and slashed the UK's economic growth trajectory. However, it should recover in the coming days.
The drop in the Pound confirms markets judge the decision to be a 'dovish' one that spells out the need for further interest rate cuts.
However, the Bank also hiked its inflation forecasts and said in the statement, "the medium-term outlook for inflation, a gradual and careful approach to the further withdrawal of monetary policy restraint is appropriate."
The inflation upgrade and commitment to "gradual and careful" rate cuts significantly limit the scope of the Bank to accelerate the cutting cycle to more than a cut per quarter.
This means the selloff in the currency looks to be a knee-jerk move and a recovery is likely over the coming days as markets adjust to the reality that the Bank will cut on three further occasions in 2025.
"The Bank also provided a surprisingly hawkish set of forecasts, warning that inflation could accelerate 'quite sharply' later this year before subsiding, and outlining a policy path that includes just two more cuts over the next three years. The pound’s losses may prove somewhat limited," says Karl Schamotta, Chief Market Strategist at Corpay.
Most of the day's GBP weakness actually happened in the run-up to the decision itself, suggesting some tactical market plays. However, further weakness followed the headline that two members of the nine-person Monetary Policy Committee (MPC) voted for an outsized 50 basis point rate cut, signalling a desire by some to accelerate the process.
The big news was that Catherine Mann, an arch-hawk who has long advocated for a higher-for-longer interest rate policy, has flipped.
"Not only has Mann ended her fight against rate cuts, but she has doubled down with a vote to slash rates by 50bp," says James Smith, Developed Markets Economist at ING Bank.
Above: GBPEUR at 15-minute intervals showing most of the selloff actually happened before the Bank of England decision was even released.
The meeting minutes show Mann wanted to send a 'clear signal' on where interest rates need to get to, whilst also recognising policy needs to stay restrictive for some time to come.
Her concerns rest with a substantial downgrade to the UK's economic growth forecasts: the growth rate to the end of the first quarter of 2025 is slashed to 0.4% y/y from the 1.4% forecast made in November 2024.
The new projections show the unemployment rate will rise gradually to around 4.75%, slightly above the 4.5% forecast in November 2024.
However, rising inflation will severely hamper the ambitions of those MPC members who thought cutting interest rates by 50bp was a good idea. The latest Monetary Policy Report, released in February, now projects CPI inflation to peak at 3.7% in Q3 2025, a significant revision from the 2.8% peak anticipated in November 2024.
Cutting interest rates is textbook inflationary, and it is hard to square how arguing for an acceleration in the pace of cuts squares with the Bank's official mandate to bring inflation back to the 2.0% target.
The forecasts combine to paint a picture of an increasingly stagflationary economy in which growth flatines and inflation accelerates.
Although the Pound will likely recover initial weakness the bigger threat to the currency over the coming weeks is that the stagflationary narrative comes to dominate. Stagflation is fundamentally negative for a currency, and this would therefore pose downside risks to Pound Sterling.