TLDR:
- Bank of England Governor Andrew Bailey suggests more aggressive rate cuts if inflation remains low
- Pound falls to two-week low following Bailey’s comments
- Markets now pricing in more rate cuts from BoE by end of next year
- Bailey watching Middle East situation closely for potential impacts on oil prices and inflation
- UK inflation recently fell to 2.2%, just above BoE’s 2% target
Bank of England Governor Andrew Bailey has indicated that the central bank could become more proactive in cutting interest rates if inflation continues to remain subdued. This shift in tone has caused a significant reaction in financial markets, with the pound falling to a two-week low against major currencies.
In an interview with The Guardian, Bailey expressed encouragement about the easing of cost-of-living pressures in the UK. He suggested that if positive inflation news persists, the Bank of England (BoE) could adopt a “bit more aggressive” and “a bit more activist” approach to reducing interest rates.
This marks a departure from the gradual approach to rate cuts that the BoE has maintained since its first pandemic-era reduction in August.
The comments come as UK inflation has fallen from double-digit levels to just above the BoE’s 2% target. The most recent data shows the Consumer Prices Index at 2.2%. While this is a significant improvement, the BoE still expects a temporary uptick in inflation this year due to higher energy prices.
In response to Bailey’s remarks, the pound dropped by more than 1% against both the US dollar and the euro.
Financial markets have adjusted their expectations, now fully pricing in a quarter-point rate cut in November and assigning a 70% probability to another reduction in December. This represents a significant shift from previous market expectations.
The BoE’s latest survey of chief financial officers also indicates easing inflation expectations. Firms now anticipate consumer prices to rise by 2.6% in the coming year, the lowest figure since the BoE began recording this data in 2022.
However, Bailey emphasized that the central bank is closely monitoring developments in the Middle East, particularly the ongoing conflict between Israel and Iran. The region accounts for about a third of global oil supply, and any disruptions could potentially impact inflation through higher energy prices.
Bailey noted that while there is currently a strong commitment to keep the oil market stable, there is a risk that control could break down if the situation worsens significantly. He stressed the importance of continuous vigilance in this regard.
The governor’s comments have led to a recalibration of market expectations. Investors are now pricing in six rate cuts from the BoE by the end of next year, up from just over five cuts earlier in the week. This shift reflects a growing belief that the central bank may be more inclined to ease monetary policy in the coming months.
Despite the recent drop, the pound remains the best-performing currency among G10 currencies so far this year.
However, market analysts suggest that Bailey’s comments have made it more challenging for the pound to recover in the short term. For a significant rebound, the UK may need to see upside surprises in price data and an easing of tensions in the Middle East.
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