BoE expected to trim interest rate amid steady inflation and weak economic growth
- The Bank of England is expected to trim the benchmark rate by 25 basis points.
- Softer UK inflation figures are overshadowed by concerns about slowing growth.
- GBP/USD could resume its bearish trend if policymakers deliver dovish clues.
The Bank of England (BoE) will announce its decision on monetary policy on Thursday after completing the first meeting of 2025. Market participants anticipate policymakers will trim the benchmark rate by 25 basis points (bps) to 4.5% after cutting it by 50 bps throughout 2024.
But it is not just about interest rates. It’s a BoE Super Thursday, so the central bank will also release the meeting Minutes alongside the Quarterly Inflation Report. Finally, Governor Andrew Bailey will hold a press conference in which he will explain the reasoning behind the policymakers’ decision.
With a 25 bps interest rate priced in, the focus will then be on the BoE's guidance and economic projections.
UK: Softer inflation and weaker growth
The BoE surprised market players in December with a hawkish hold, as six out of nine members of the Monetary Policy Committee (MPC) voted to keep rates on hold, while the other three opted for a rate cut.
Meanwhile, the Office for National Statistics (ONS) reported that the United Kingdom (UK) annual headline inflation edged lower to 2.5% in December from 2.6% in November. Additionally, the annual core inflation rate decreased to 3.2% in December from 3.5% prior, marking the lowest reading since September. More importantly, services inflation hit 4.4% year-on-year (YoY), below the BoE’s projection.
Growth, on the other hand, has been tepid, to say the least. The UK Gross Domestic Product (GDP) registered no growth in the third quarter of 2024, revised down from the first estimate increase of 0.1%, according to the latest ONS report. Q2 was downwardly revised to 0.5% following an initial estimate of 0.6%. The BoE expects zero GDP growth in the last quarter of 2024, downgrading the 0.3% estimate predicted in November.
With the 25 bps interest rate cut fully priced in, the focus will be on the MPC report and Governor Bailey’s speech. UK policymakers will offer an updated assessment of the economy’s potential growth rate, with the latest estimate standing at 1.3%. A downward revision seems likely, which should boost the odds for additional rate cuts in the upcoming meetings, albeit a faster pace of trims seems out of the picture at the moment.
Additionally, it is worth remembering the recent surge in UK government bonds, so-called Gilts, yields. UK Gilts yields have risen to multi-year highs at the beginning of the year, spurring concerns about government spending and tax decisions. Many analysts link the advance to that of United States (US) Treasury yields following President Donald Trump’s arrival at the White House.
Nevertheless, yields retreated in the last couple of weeks amid mounting concerns that the economic slowdown would deepen under Trump’s tariff plans. These concerns also fueled speculation the BoE will have no choice but to trim interest rates.
How will the BoE interest rate decision impact GBP/USD?
As previously mentioned, a BoE 25 bps interest rate cut is fully priced in. With that in mind, the British Pound (GBP) will likely show no reaction to the headline but react to policymakers’ fresh economic projections and how MPC votes. Ahead of the announcement, financial markets anticipate eight of the nine members will opt for a rate trim. Investors will also pay close attention to Governor Andrew Bailey’s words.
Generally speaking, the more dovish the outcome, the more the GBP could fall. The opposite scenario is also valid, with hawkish surprises from UK policymakers boosting demand for the British Pound.
Ahead of the announcement, the GBP/USD pair trades above the 1.2500 mark, recovering from a weekly low of 1.2248. The US Dollar (USD) soared at the beginning of the week as US President Donald Trump announced tariffs on imports from Mexico, Canada and China over the weekend. The subsequent USD decline came after Trump postponed the implementation of such levies, at least on Mexican and Canadian imports.
Valeria Bednarik, Chief Analyst at FXStreet, says: “Central Bank’s decisions and macroeconomic data in general is being overshadowed by US President Trump's decision to unleash a trade war. The UK is not out of Trump’s radar, but it is definitely not among his top rivals. Still, the risk of the UK economic slowdown accelerating amid fresh US tariffs pends on policymakers ahead of the announcement. As for GBP/USD, the pair may resume its slump with a dovish tilt, albeit the reaction could be limited as investors anticipate it. If policymakers sound hawkish, the GBP/USD will likely gain extra upward traction.”
Bednarik adds: “The GBP/USD pair has an immediate resistance level at the 1.2600 threshold, with gains beyond the area exposing 1.266, the December 19 daily high. Beyond the latter, the rally could continue towards the 1.2700-1.2720 area en route to the 1.2800 figure. The 1.2470 price zone provides support ahead of the 1.2400 figure. A break below the latter could see the pair resuming its bearish trend and retesting the aforementioned weekly low at 1.2248.”
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
Economic Indicator
BoE Interest Rate Decision
The Bank of England (BoE) announces its interest rate decision at the end of its eight scheduled meetings per year. If the BoE is hawkish about the inflationary outlook of the economy and raises interest rates it is usually bullish for the Pound Sterling (GBP). Likewise, if the BoE adopts a dovish view on the UK economy and keeps interest rates unchanged, or cuts them, it is seen as bearish for GBP.
Read more.Next release: Thu Feb 06, 2025 12:00
Frequency: Irregular
Consensus: 4.5%
Previous: 4.75%
Source: Bank of England
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