The fate of the British pound is firmly in the hands of the central bank

The British pound is recovering from the blow it took after a rate cut in early August. Currency markets expect the Bank of England (BoE) to pause for now. Or is chairman Andrew Bailey secretly preparing for a rate cut?

The United Kingdom has had a good summer in economic terms. In mid-July, the British Office for National Statistics announced that the economy had grown at its fastest pace in more than two years in the three previous months. In May alone, the economy expanded by 0,4%. That percentage was twice as high as economists had expected. For several investment banks, the windfall prompted them to increase their expected growth rate for the whole of 2024 from around 1% to 1,5% or more. Prime Minister Keir Starmer even promised that economic growth could eventually blossom to the 2,5% of the early XNUMXs.

Stimulating economic growth
Starmer took office this summer after his Labour Party’s landslide victory in the July 4 general election. He plans to ease strict rules for housebuilders and boost growth sectors through targeted infrastructure investment. And Starmer hopes that Labour can entice foreign investors to invest in the UK by pursuing a more predictable policy than the Conservatives, whose rule was marked by chaotic Brexit negotiations and a trial budget by former Prime Minister Liz Truss that caused major unrest on financial markets.

Sharp price movement
In practice, however, the Bank of England's policies have at least as much influence on the economy as Starmer's measures. A few days after the publication of the economic growth figures, the pound reached its highest rate against the euro in more than two years. In early August, however, the currency took a step back by more than 2%. This sharp movement of the year followed the central bank's decision to cut the policy rate by 25 basis points to 5%. BoE chairman Andrew Bailey also hinted that this rate may fall somewhat faster in the future than the currency markets had anticipated.

Take care
In a speech last Friday, Bailey said that inflation is clearly coming down. He noted that it is too early to really give the all-clear. Currency traders saw this as an indication that the BoE will not cut its policy rate further in September. On the other hand, a rate cut by the European Central Bank in that month is almost certain. The widening interest rate differential makes it more attractive for parties to hold assets in pounds. That explains why the currency has rebounded again in August after the initial shock of the rate cut. However, an inflation of 2,2% does give the BoE room for a rate move. If that happens, currency markets will be completely wrong-footed.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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