Sterling Sits Between a Cautious Bank of England and Hawkish Peers

UK inflation rose to 3.1% year on year in August, up from 2.9% in July and the highest reading since March, and the Bank of England is still expected to leave interest rates unchanged. That gap between rising prices and an unchanged policy rate is what puts sterling policy divergence at the center of this meeting, because the pound now trades on the distance between the Bank of England and its peers rather than on anything the Bank Rate does. Core inflation held at 2.6% and services inflation, an indication of domestic price pressures, held at 3.4%, so the inflation mix gives the Monetary Policy Committee little fresh reason to move. Meanwhile the Federal Reserve and the European Central Bank are working through their own decisions, and the European Central Bank was read as slightly more hawkish.

Fiona Cincotta is a StoneX Senior Market Analyst with more than 15 years trading and analyzing UK, European and U.S. markets, working across foreign exchange, equities and commodities. She follows the UK and European macro themes that connect central bank policy to currency and bond market conditions, which is the ground this decision sits on.

Key Themes

• UK inflation reached 3.1% in August, its highest level since March, while core and services inflation held steady.
• A weakening UK labor market is containing price pressures, offsetting rising petrol and food costs.
• The pound trades on the policy gap with the Federal Reserve and the European Central Bank, not on Bank Rate.

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Bank of England Caution Widens the Policy Gap Weighing on Sterling

A Bank of England hold arrives while other major central banks are hiking, and that contrast is the mechanism working against the pound. The Monetary Policy Committee vote is expected to stay at 6 to 3, with Hugh Pill, Megan Green and Catherine Mann voting to hike, and a more hawkish count than that would be the outcome capable of supporting sterling. The base case, though, is that the Bank of England does not turn materially more hawkish, because Bank of England Governor Andrew Bailey has stressed that he wanted to see clear signs of "higher energy prices feeding into larger pay rises or broad based price increases" before hiking rates, and Cincotta notes that neither has shown up yet. The pound is exposed to a relative-rates problem it cannot fix domestically, with the Federal Reserve deciding separately and the European Central Bank already read as the more hawkish of the two. For a trader, that means the reaction function sits abroad as much as it sits in London.

Slower Gilt Sales Cut Supply and Split the Pound's Reaction

The Bank of England is expected to slow the pace at which it offloads government bonds from its balance sheet, and that is the part of the meeting with a direct market plumbing effect. Fewer sales mean "less additional supply for investors to absorb", which technically should help support gilt prices and bring yields lower. Whether that helps sterling depends entirely on interpretation, because a slower program read as less monetary tightening points one way while the same move read as the central bank preventing disorderly moves in the gilt market points the other. As Cincotta puts it, in the second case it "may actually be seen as reassuring and help to support the pound". The practical takeaway is that gilt yields, not sterling, may be the cleaner read on what this decision actually changes.

 

--- Written by Frédéric Guétin, StoneX Media Producer

--- Expert: Fiona Cincotta, StoneX Senior Market Analyst