Andrew Bailey was in a rare upbeat mood today, and he is happy with the outlook for inflation. The Bank of England kept rates on hold, as expected, however, there was a notable shift to a more dovish stance. After December’s rate cut, the market was not expecting a consecutive cut at today’s meeting, however, there was an expectation that the vote split would be 7-2 in favour of remaining on hold. The split was much tighter, with 5 members voting for no change, and 4 members voting for a cut.

A close call to remain on hold

It was a close call to keep rates on hold today, and members that voted to cut rates included Dhingra, Taylor, Ramsden and Breedon. The Bank also released its latest economic forecasts. The Bank reduced its GDP forecast for this year to 0.9%, it also dramatically cut its inflation forecast by 0.7% to 2.1%, which is practically the BOE’s target rate. Bailey was happy with this and noted that inflation is set to return to the target a year earlier than expected in November.

The BOE also expects the unemployment rate to rise in the coming months to 5.3%, and for private sector wage growth to moderate further. In the future, the BOE sees inflation falling below target in the first few months of 2028, which supports a rate cut to protect against deflation risks.

Market reacts to dovish reduction in CPI forecasts

The market reaction has been swift, the pound has fallen and GBP/USD is trailing around the lows of the day, although the move so far has been small. There has been a sharp decline in front-end UK bond yields, and the 2-year yield is lower by 8 bps so far, as the market rushes to price in a near term rate cut. The market has fully priced in the prospect of a cut by the BOE’s meeting in April, however, there is also a growing chance of a cut at the next meeting in March, the interest rate futures market is now pricing in a near 60% chance of a cut next month.

Downside pressure on GBP likely to persist

This is likely to keep downside pressure on GBP, and the pound is the weakest currency in the G10 FX space today. EUR/GBP has surged today and is back above the 200-day sma and this pair is now testing the air above 0.8700. GBP/USD is looking vulnerable and could test the 200-day sma at $1.3430, depending on what Andrew Bailey says in the press conference that is ongoing. He was the swing voter today, and voted to keep rates on hold, after supporting a cut in December. Whether or not the pound drops further, could depend on how urgent he sees a cut: will he vote for a cut in March, or does he want to see more evidence and a cut may be delayed until April?

The BOE is clear, rate cuts are coming, and it is no wonder the pound is falling along with UK bond yields.

Chart 1: GBP/USD looks vulnerable

Source: XTB and Bloomberg

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