After the market sent out the first warning signs of the new UK budget on Wednesday, it continued seamlessly yesterday, with UK government bond yields rising sharply and the pound depreciating. Moreover, since Tuesday, a rate cut of around 25 basis points by next September has been priced out. Clearly, the market has serious concerns about the new budget, Commerzbank’s FX analyst Michael Pfister notes.
BoE rate cut next week is still likely
“Although a lot of information was deliberately leaked in the run-up to the release market participants were surprised by the extent to which the new budget is geared towards delivering more growth in the short term. In the long run, stronger growth would certainly be seen as a positive, but until then it is a bold gamble that needs to pay off. And in the short term, it is likely to increase inflation risks, which means that the Bank of England (BoE) will be less likely to cut interest rates.”
“We should remain calm for now. A BoE rate cut next week is still likely. And while the risks of another rate pause at the December meeting have increased, it should be remembered that the BoE has been rather dovish of late. It will probably want to cut rates sooner rather than later, which means that another cut in December is still on the table. Of course, a lot depends on how next week’s decision is communicated. However, if inflation does not pick up significantly in the coming weeks, the BoE is likely to continue its rate-cutting cycle despite the current market jitters.”
“Even if further rate cuts are on the way, we still think that the pound should strengthen against the euro by the end of the year. This may seem confusing at first glance. However, it is simply supported by continued slightly stronger UK growth and more persistent inflation, which should lead the BoE to emphasise its caution despite the rate cuts. Meanwhile, the ECB has more reason to look beyond inflation as the real economy weakens. This should support the GBP against the EUR.”