Overview

The British pound experienced a significant drop of over 1% against the US dollar on Thursday, marking its largest daily decline since October of the previous year. This decline followed remarks from Bank of England (BoE) Governor Andrew Bailey, who indicated that the central bank might adopt a more aggressive approach to cutting interest rates if inflationary pressures continue to diminish.

Key Points

• Current Exchange Rate: Sterling fell from $1.3268 to $1.3121, extending its downward trajectory from last week when it was trading above $1.34.
• Market Reaction: Following Bailey's comments, investors increased the likelihood of two quarter-point rate cuts this year to 75%, up from 50%.

Bailey's Comments

Bailey's statements challenged previous investor expectations that the BoE would reduce rates more slowly compared to the Federal Reserve and the European Central Bank due to ongoing price pressures in the services sector. He noted:

• "Given that inflation in the UK has been higher than in the US and Europe, the market has been pricing a shallower cycle. But these comments suggest that the BoE could go faster."

Inflation Insights

UK inflation remained stable at 2.2% in August; however, services inflation—an essential measure for the BoE—rose from 5.2% in July to 5.6%. Despite this, Bailey expressed optimism that cost of living pressures were not as persistent as previously anticipated, stating:

• If inflation trends continue positively, there is potential for a more activist stance on interest rate cuts.

Recent Rate Decisions

The BoE maintained interest rates at 5% last month but hinted at possible cuts as early as November. In August, the bank reduced rates from a 16-year high of 5.25%, marking its first cut in over four years.

Business Survey Findings

A recent survey from the BoE revealed ongoing price pressures within the economy:

• Businesses forecast wage growth of 4.1% over the coming year.
• Companies expect to raise prices by an average of 3.6% within the same timeframe.

Rob Wood, an economist at Pantheon Macroeconomics, commented on these findings, stating:

• "This shows stubborn wage and price growth, supporting only gradual interest rate cuts."

Conclusion

The market's response to Bailey's remarks highlights a shift in expectations regarding UK monetary policy and its potential impact on the economy moving forward.