Sterling slid off a two-week high on Thursday and British share prices rose modestly on expectations that the Bank of England would ease monetary policy soon after it surprised many in the markets by leaving interest rates unchanged.
Eight out of the nine members of the BoE’s monetary policy committee voted to keep rates on hold at 0.5 per cent, wrong-footing the many investors who had expected a cut.
Sterling forward interest rates, which had almost completely priced in a cut on Thursday, shifted briefly to remove any chance of rates going lower than 0.25 per cent this year. In afternoon trade, they were once again pricing in a move below 0.25 per cent in 6 months time.
Sterling soared to as high as $1.3480 after the BoE announcement, up more than 2 per cent on the day and its strongest since June 30, having traded at $1.3210 beforehand. It later pared those gains to trade at $1.3320, up 1.3 per cent.
The pound was on track for a more than 2.8 per cent weekly rise against the dollar – its best performance since 2009. Nevertheless, traders said the bounce is unlikely to last long given expectations of easier monetary policy.
The BoE said it was likely to deliver stimulus in three weeks’ time, possibly as a “package of measures”, once it has assessed how the Brexit vote has affected the economy.
“Given that officials left the door wide open for action in August, confirming (BoE chief Mark) Carney’s comments on policy easing over the summer, we will treat the positive knee-jerk reaction in sterling as providing a strategic selling opportunity,” said Charalambos Pissouros, senior analyst at IronFx Global.
“Potentially soft post-referendum data combined with expectations for August easing could bring sterling under renewed selling interest over coming weeks.”
Sterling has been boosted this week by Theresa May becoming Britain’s new prime minister, which somewhat eased the political uncertainty prevailing since its June 23 vote to leave the European Union, and had driven sterling to a 31-year low of $1.2798 last week.
The sharp drop in the pound in the past few weeks translated into easier financial and monetary conditions, analysts said, enabling the BoE to buy more time until next month.
STOCKS EKE OUT GAINS
Against the euro, too, sterling gained as much as 2 per cent to hit a two-week high of 82.51 pence, before trimming gains to trade at 83.50 pence, around 1 percent up on the day. Before the policy announcement the euro had traded at around 84 pence.
Money market rates showed a slimmer chance of a rate cut from the European Central Bank next week. Forward EONIA rates showed around a 20 percent chance of a 10 basis points cut, down from around 30 percent before the BoE meeting.
For the BoE, though, analysts think it is only a matter of time before rate cuts and quantitative easing are announced.
“Today’s decision simply delays the start of the easing cycle by three weeks until the next meeting, which also corresponds with the publication of the central bank’s quarterly inflation report,” said Sam Lynton-Brown, strategist at BNP Paribas.
“Political uncertainty remains very elevated in the UK, and this will continue to undermine confidence in the UK’s ability to fund its more than 5 percent of GDP current account deficit. Our current forecasts put the pound at $1.28 by the end of Q3.”
The blue chip FTSE 100 and mid-cap FTSE 250 were both trading higher amid hopes of more stimulus.
British government bond yields rose sharply. The 10-year gilt yield rose around 4 bp to the day’s high of 0.815 percent, before easing back to 0.795 per cent.
Short sterling interest rate futures <0#FSS:> turned negative, falling around 4 to 7 ticks across the 2016 and 2017 contracts.