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Pound tumbles, gilts rally after BoE nods at rate cut ahead

bank of england building in london
Spring flowers bloom in front of the Bank of England building, in London

The pound fell, while UK government bond prices rallied on Thursday after the Bank of England kept interest rates unchanged but sigalled the economy was moving in the right direction for it to start cutting rates.

The BoE kept its benchmark rate at 5.25% – its highest since 2008 – as had been widely expected, a day after data showed inflation fell to its lowest in almost two-and-a-half years but stayed too high for comfort.

Sterling fell by as much as 0.48% to a session low of $1.2726 after the decision, from around $1.275 earlier on. It is still on course for a 1% rise against the dollar this month. Against the euro, the pound was down 0.3% at 85.63, from around 85.55 earlier.

Two-year gilt yields, the most sensitive to shifts in rate expectations, dropped by as much as 12.8 basis points to the day’s low at 4.103%, as prices rallied.

The BoE’s interest rate-setters voted 8-1 to keep borrowing costs at their 16-year high of 5.25% on Thursday as the two officials who had previously called for higher rates changed their stance.

“That’s what really caught my eye – the two hikes last meeting have turned more neutral and looking to keep rates on hold,” Fiona Cincotta, a market strategist for City Index, said.

“Overall that must make for a less hawkish position from the central bank. And you can see the ship is turning towards that rate cut and that is what the pound has grasped on to,” she said.

Britain’s headline inflation rate, which topped 11% in October 2022, fell by a bit more than expected to 3.4% in February from 4.0% in January but was still the highest in the Group of Seven.

Stubborn inflation in the UK has supported sterling this year. The pound is one of the best performers so far, driven by the expectation that other major central banks will start cutting rates before the BoE.

After the BoE decision, money markets were pricing a 75% chance of a rate cut in June, up from closer to 65% earlier in the day.

Also on Thursday, the Swiss National Bank delivered a surprise quarter-point cut, making it the first major central bank to dial back tighter monetary policy aimed at tackling inflation, while Norges Bank kept its rate unchanged.

The Bank of Japan ditched on Tuesday negative interest rates and raised rates for the first time in 17 years, while on Wednesday the Federal Reserve indicated it remained on course to cut rates three times this year but stayed on alert about the path of price growth ahead.

Separately, a survey on Thursdsay showed British businesses kept up their recovery from recession this month, while inflationary pressures showed no sign of rapidly abating, potentially complicating matters for the BoE.

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