Sterling slumped to its lowest level since October against the euro as the Bank of England (BoE) cut its economic forecasts, prompting traders and economists to conclude that it will be next year at least before interest rates in the world’s fifth-largest economy will rise.
The downgrades, linked to Brexit, were enough for the majority of the bank’s monetary policy committee to vote to keep official borrowing costs at their all-time low of 0.25 per cent, according to minutes from their meeting released on Thursday.
In its quarterly inflation report, also published on Thursday, the bank cut its economic growth for this year and next to 1.7 per cent and 1.6 per cent, down from previous projections of 1.9 per cent and 1.7 per cent respectively.
"The chances of a 2017 rate hike now look dead and buried," said Jake Trask, foreign exchange research director at OFX in London. "Ongoing concerns around Brexit combined with questions about wage growth to hit the pound hard."
Sterling fell by as much as 0.9 per cent against the euro during European trading, to 0.90487p. If sustained, the move that will weigh on exporters, visitors to the State from the UK and earnings of companies that generate much of their earnings on the other side of the Irish Sea and report in euro.
The exchange rate has oscillated between 0.83558p and 0.9182p in the past year.
Inflation
The new BoE forecasts reflect the deterioration of the economic outlook since May as faster inflation outpaces wage gains, holding back consumer spending. While the bank sees the weaker pound and stronger global growth bolstering exports, uncertainty surrounding the UK's talks to leave the European Union is creating a drag.
But the bank also said that a response to above-target inflation and domestic price pressures would be needed. If the economy performs as it expects, the benchmark interest rate will need to rise by a “somewhat greater extent” than markets currently anticipate, it said.
The BoE’s forecasts continue to assume a smooth Brexit and are based on a rate hike fully priced in by the third quarter of 2018.
Underlying the squeeze on households from inflation, real wages will fall by 0.5 per cent this year, according to the BoE’s new forecast. Average weekly earnings will improve in 2017, but at a slower pace than previously thought.
Given weak productivity, the BoE still sees economic growth being enough to generate domestic inflation pressure and close the UK’s output gap within three years. Inflation, which will peak at about 3 per cent in October, will slow to about 2.2 per cent in 2020, just above the bank’s 2 per cent target.
Tim Graf, head of macro strategy for the Europe, Middle East and Africa regions at State Street Global Markets, said “a rate hike [is] now looking unlikely for the remainder of this year, probably much longer”. – (Additional reporting: Bloomberg)
