By Yoruk Bahceli and Amanda Cooper
LONDON (Reuters) -Sterling rallied sharply on Thursday, solidifying its position as the best performing major currency of 2024, while UK-focussed stocks rose, after the Bank of England cut rates, but indicated future cuts may be more gradual than many had thought.
The BoE, which delivered its second rate cut since 2020, said that after Labour Party finance minister Rachel Reeves’ high-tax, high-spend budget last week, it expected higher inflation and growth.
London-listed shares of mid-sized companies touched session highs, while UK government bonds headed for their best one-day performance in almost a month, reflecting investor demand for sterling-denominated assets.
Sterling rose by as much as 0.68% to $1.2967 after the decision , while two-year gilt yields fell 3 basis points to 4.482%, as bond prices rose .
The Monetary Policy Committee (MPC) voted 8-1 to cut rates to 4.75% from 5%, a stronger majority than expectations in a Reuters poll for a 7-2 vote in favour of a cut.
The BoE predicted last week’s budget, which contained big increases in tax, spending and borrowing – would boost the size of Britain’s economy by around 0.75% next year but barely improve annual growth rates in two or three years’ time.
It said the budget was likely to add just under half a percentage point to the rate of inflation at its peak in just over two years’ time, causing inflation to take a year longer to return sustainably to its 2% target.
Right now, money markets show traders believe UK rates could fall by just over half a percent next year – something economists and analysts believe is too tame, given the BoE’s predictions predate the rise in gilt yields and the shift in market borrowing rates following the budget.
“Remember, markets are pricing fewer than three rate cuts from here on in,” James Smith, developed markets economist – UK, at ING said.
“We don’t think that sounds particularly realistic. Our view is that rate cuts will be cut at every meeting from February until rates reach 3.25% next autumn.”
British inflation has proven far more stubborn than that in other developed nations, particularly where wages and the services sector are concerned.
As such, UK rates remaining higher for longer and then falling more slowly than elsewhere has been a key driver of sterling strength this year.
The pound is the best-performing major currency against the dollar this year, up nearly 2% with Thursday’s rally.
(Additional reporting by Samuel Indyk; Editing by Alun John and Dhara Ranasinghe)
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