BOE may allow a weaker pound to fight Trump war and stagflation

·       The UK economy is already in stagflation and an all-out Trump trade war 2.0 may cause an all-out recession

·       The BOE may cut 75-100 bps in 2025 against the Fed’s 50-75 bps depending upon the i8nflation/growth/employment equation and Trump tantrum

·       Like the Fed, the BOE has also to bring down super core CPI inflation to around 1.4% pre-COVID targets from present levels of 3.2%, keeping the unemployment rate at least around 4%

·       On early Friday, Wall Street Futures and Gold wobbled on mixed US NFP/BLS job data

On Thursday, some focus of the market was also on the Bank of England (BOE) after a hawkish hold by the Fed a few days ago amid Trump 2.0 policy uncertainty. After the Ukraine and Gaza war uncertainty, EU/Europe as well as the U.K. is now also under stagflation and a potential all-out Trump tariff tantrum, ECB, BOE, SNB and all other major European Central Banks are now cutting rates to fight an all-out Trump trade war 2.0

On Thursday, as highly expected, the BOE cut all its key policy rates by 25 bps to mark the third rate cut since the start of its cutting cycle in Aug’24. All nine members of the Monetary Policy Committee (MPC) voted for a rate cut (9-0), compared with a market consensus of 8-1, while two members voted for a steeper 50bps cut, including known BOE hawk Mann, joined known dove Dhingra in supporting the larger cut.

On Thursday, the BOE cut 25 bps each for its key/reference policy bank deposit (reverse repo) rate at +4.50% and also lending (repo) rate at +4.75%. The BOE maintained its stance that monetary easing is expected to be gradual this year, as mounting growth concerns weigh against stubborn levels of underlying services inflation. Still, the BOE revised its growth forecasts for the current year downward as economic activity has already underperformed expectations from November, indicating a dovish shift in the risk balance between growth and higher prices in the near term.

The MPC's decision reflects concerns over the UK's economic outlook. The BOE now sees U.K. real GDP growth at around +0.4% in 2025 vs earlier projections of +0.9%, while headline CPI inflation is +2.8% vs earlier projections of +2.6% and the unemployment rate is 4.5% vs earlier projection 4.6%. In 2024, the UK real GDP growth may come to around +0.9% vs potential or BOE targets around 1.5-2.0%; the UK’s pre-COVID CY2019 real GDP growth was around +1.6%; core CPI +1.4% (equivalent to Fed core PCE and ECB core HICP); and unemployment rate 3.9%. At present, the UK unemployment rate is around 4.4%, and core CPI inflation is 3.2%.

The BOE has halved its GDP growth forecast for 2025, citing stagnation in output and a subdued demand outlook. Inflation is expected to rise to 3.7% by the summer, driven by short-term factors such as increased utility costs. Despite these inflationary pressures, the MPC believes that a weakened job market will prevent a wage-price spiral, leading to stagnant living standards. The BOE Governor Andrew Bailey justified the forecasts based on short-term utility costs.

The rate cut aims to stimulate economic growth, but the Bank remains cautious due to persistent inflation and a fragile economy. The MPC's vote indicates heightened concerns about the UK's economic health, with only two members supporting a larger rate reduction. This move is expected to be welcomed by Chancellor Rachel Reeves, who faces fiscal challenges ahead of the summer spending review. Financial markets, which had anticipated only two more cuts this year, may now expect a more aggressive pace of monetary easing.

The BOE cut only 50 bps in 2024 against the Fed and ECB’s 100 bps. BOE’s repo rate is now 4.75% against the Fed’s 4.50% and          ECB’s 3.15%. In pre-COVID times *Dec’19, the Fed’s repo rate was +1.75%, BOE’s +0.75% and ECB’s +0.25%. Now in 2025, the Fed is expected to cut 50 bps. Thus to match the pre-COVID interest rate differential with the Fed, the BOE may cut also another 50 bps in 2025; i.e. cumulative -75 bps in 2025.

Reasons for the BOE Rate Cut on 6th Feb’25

Progress on Disinflation: The BoE indicated that significant progress has been made in disinflation over the past two years. This is attributed to the receding of previous external shocks and the restrictive stance of monetary policy curbing second-round effects and stabilizing longer-term inflation expectations.

Inflation Target: The MPC aims to meet the 2% inflation target while sustaining growth and employment. The committee felt there had been sufficient progress on disinflation in domestic prices and wages to reduce the Bank Rate to 4.5%.

Economic Stimulus: The Bank of England stated that sufficient progress had been made in the fight against inflation to warrant economic stimulus.

MPC Comments and Governor Bailey's Remarks:

·       BoE Governor Andrew Bailey explained the decision to lower the policy rate

·       Bailey indicated that the BoE expects to be able to cut the bank rate further as disinflation continues

·       The MPC acknowledged that domestic inflationary pressures are moderating but remain somewhat elevated, with some indicators easing more slowly than expected

·       The BoE also released the meeting Minutes alongside the Quarterly Inflation Report

·        The BOE subtly downplayed concerns about the effect of Trump 2.0 on global economies

·       The BoE expects to cut rates further as the disinflation continues

·       Governor Bailey said that the BoE will watch very closely what the Trump administration does on trade and that he is sure there will be a very open dialogue between the UK and US administration

Future Expectations:

·       Markets are pricing in another 50-75 basis points of cuts in 2025; i.e. 2-3 rate cuts every quarter @25 bps

The relevant text of BOE’s statement: 6th Feb’25- Bank rate maintained at 5.25%

Monetary Policy Summary

The Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. The MPC adopts a medium-term and forward-looking approach to determine the monetary stance required to achieve the inflation target sustainably.

At its meeting ending on 5 February 2025, the MPC voted by a majority of 7–2 to reduce Bank Rate by 0.25 percentage points, to 4.5%. Two members preferred to reduce Bank Rate by 0.5 percentage points, to 4.25%.

There has been substantial progress on disinflation over the past two years, as previous external shocks have receded, and as the restrictive stance of monetary policy has curbed second-round effects and stabilized longer-term inflation expectations. That progress has allowed the MPC to withdraw gradually some degree of policy restraint while maintaining Bank Rate in restrictive territory so as to continue to squeeze out persistent inflationary pressures.

CPI inflation was 2.5% in 2024 Q4. Domestic inflationary pressures are moderating, but they remain somewhat elevated, and some indicators have eased more slowly than expected. Higher global energy costs and regulated price changes are expected to push up headline CPI inflation to 3.7% in 2025 Q3, even as underlying domestic inflationary pressures are expected to wane further. While CPI inflation is expected to fall back to around the 2% target thereafter, the Committee will pay close attention to any consequent signs of more lasting inflationary pressures.

GDP growth has been weaker than expected at the time of the November Monetary Policy Report, and indicators of business and consumer confidence have declined. GDP growth is expected to pick up from the middle of this year. The labor market has continued to ease and is judged to be broadly in balance. Productivity growth has been weaker than previously estimated, and the Committee judges that growth in the supply capacity of the economy has weakened. As a result, the recent slowdown in demand is judged to have led to only a small margin of slack opening up.

In support of returning inflation sustainably to the 2% target, the Committee judges that there has been sufficient progress on disinflation in domestic prices and wages to reduce the Bank Rate to 4.5% at this meeting.

Based on the Committee’s evolving view of the medium-term outlook for inflation, a gradual and careful approach to the further withdrawal of monetary policy restraint is appropriate.

In addition to the risks around inflation persistence, there are also uncertainties around the trajectories of both demand and supply in the economy that could have implications for monetary policy. Should there be a greater or longer-lasting weakness in demand relative to supply; this could push down on inflationary pressures, warranting a less restrictive path of Bank Rate. If there were to be more constrained supply relative to demand, this could sustain domestic price and wage pressures, consistent with a relatively tighter monetary policy path.

The Committee will continue to monitor closely the risks of inflation persistence and what the evolving evidence may reveal about the balance between aggregate supply and demand in the economy. Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee will decide the appropriate degree of monetary policy restrictiveness at each meeting.”

BOE MONETARY POLICY PRESS CONFERENCE: Thursday 6 February 2025

Opening remarks by Andrew Bailey, Governor

“Today, we have cut Bank Rate by 0.25 percentage points, to 4.5%. With the progress we have made to reduce inflationary pressures in the UK economy, we have been able to take another step to make monetary policy less restrictive. This will be welcome news to many.

We expect to be able to cut Bank Rate further as the disinflation process continues. But we will have to judge the meeting by meeting how far and how fast. We live in an uncertain world, and the road ahead will have bumps. We expect inflation to increase this year, to a peak of about 3.7%, before returning to the 2% target. We will set the Bank Rate to ensure that it does so sustainably. Low and stable inflation is the foundation of a healthy economy, and we will do our job to continue to ensure that.

Behind this uptick in headline inflation, however, stands a continued, gradual easing of underlying inflationary pressures in the UK economy. This is the backdrop to our withdrawal of monetary policy restrictiveness and our policy decision today. Inflation in the prices of services has been coming down since the middle of last year. In the latest data for December, services inflation fell more than expected to 4.4%. Some of that downside surprise was driven by smaller-than-expected increases in airfares, which can be volatile. But other measures of underlying services price inflation have been gradually easing too.

And higher frequency measures of underlying services price inflation, which can be indicative of near-term inflation momentum, have remained lower than their annual rates. These points to a prospect of further moderation in underlying services price inflation. Wage growth remains an important factor behind the remaining persistence in service price inflation. Annual growth in private-sector regular average weekly earnings (AWE) increased to 6.0% in the three months to November. This may suggest that the disinflationary process has slowed in recent months.

The news from other measures of private-sector regular pay growth has been mixed. The Bank staff’s indicator model of underlying pay growth has plateaued recently, but it still points to a lower rate of wage growth (orange line) than the AWE. Both the Bank’s Decision Maker Panel and our Agent’s annual pay survey point to a softening in wage growth over this year, to just below 4% and 3.7%.

So while we expect inflation to rise again over the coming months, it is almost entirely due to factors that are not directly linked to underlying cost and price pressures in the UK economy – factors that we expect to be temporary. The combined effects of regulated price changes and fiscal measures may add around half a percentage point to inflation towards the middle of this year. But the single largest driver is household energy bills. With current expectations for wholesale prices, energy prices may contribute as much as three-quarters of a percentage point to the increase in headline inflation expected towards the middle of the year.

The winter has been colder than expected in Europe and that has led to an increase in demand for natural gas while supply has remained tight. Wholesale natural gas futures prices have risen by around 20% since our November Report. The increase in European gas prices has led to an increase in the Ofgem price cap for UK household energy bills for the current quarter, and it will affect the cap for the second quarter of this year too when it is announced by Ofgem later this month. But gas futures prices remain significantly lower than in 2022, and they are little changed further out. While energy prices are volatile and notoriously hard to predict, these are developments that should help to limit further increases in energy prices.

Monetary policy cannot prevent such short-term influences on headline inflation, nor should monetary policy respond to factors that will fade by the time monetary policy takes effect. But we should recognize that this short-term pick-up in inflation introduces some further uncertainty into the near-term outlook for inflation. Utility and food prices are salient to the consumer, and we have to make sure that temporary increases in them do not feed through to lasting second-round effects on wages and other prices.

With the underlying disinflationary process well underway and a continued restrictive stance of monetary policy in place, we can, however, be reasonably confident that the pick-up in inflation we see ahead of us will be temporary – and much smaller and less prolonged than the one we have just put behind us.

Today, the labor market is cooling. The context is one of a weakling in economic activity. Intelligence from the Bank’s Agents suggests that firms are increasingly either reluctant or unable to pass through costs to consumer prices given subdued demand. These are signs that the restrictive stance of monetary policy continues to work to reduce inflationary pressure in the UK economy.

So looking further ahead to our February projection – which is conditional on the market-implied path for interest rates – suggests that consumer price inflation will peak this year at around 3.7% and then fall steadily back to the 2% target over the rest of the forecast period.

In our projection, the return of inflation to target is supported by an emerging degree of economic slack in the UK economy. Activity in the UK economy has been weaker than expected last year. And we now expect GDP growth to be notably weaker in the near term too before picking up from the middle of the year. We expect similar growth rates for 2026 and 2027 as we did in November.

There is considerable uncertainty over the extent to which this weakness in UK GDP should be ascribed to demand or to supply, and so what that weakness means for inflation. Metrics of business and consumer confidence have deteriorated over recent months, and contacts of the Bank’s Agents report that consumers are more price-conscious and holding back on spending. This is consistent with a slowdown in demand. Equally, the disinflationary process has been slow too, and both services price inflation and pay growth remain at elevated levels.

Price balances in business surveys have increased, while activity balances have fallen. This suggests that demand has been slowing against the backdrop of continued weakness in the potential supply capacity of the UK economy.

Our February projection ascribes much of the weakness in economic activity to supply. This means that the more recent slowdown in demand has so far led to only a small margin of slack opening up. The output gap then widens over the next couple of years of the projection to around three-quarters of a percent of potential GDP, before narrowing towards the end of the forecast period.

This is consistent with current measures of slack in the economy. Both the level of vacancies and the ratio of vacancies to unemployment have returned close to pre-pandemic levels, suggesting that the labor market is broadly in balance.

I would also note that the ratio of broad money to GDP has returned close to its pre-pandemic trend, though it is clear that the slope of the current direction of travel is down. While we would expect the underlying disinflationary process to continue, the balance between aggregate demand and supply is one of the main determinants of inflationary pressures in the medium term. This will influence the path for Bank Rate.

On the one hand, greater or longer-lasting weakness in demand relative to supply would push down on inflationary pressures, consistent with a less restrictive path for Bank Rates. On the other hand, if supply is more constrained relative to demand, domestic wage and price pressures could be sustained, consistent with a slower pace of future reductions in Bank rates.

There are risks from the global economy too. It remains unclear what form global trade policies might ultimately take, and the MP’s February projection is not conditioned on any change in global tariffs. A Box in the Monetary Policy Report sets out a framework for how tariffs could affect UK output and inflation.

Let me conclude.

Our restrictive stance on monetary policy has reduced inflationary pressures in the UK economy. With the progress we have made, we have been able to take another step in making monetary policy a little less restrictive today. The judgment we will have to make at our future meetings is whether underlying inflationary pressures in the UK economy are easing enough to allow further cuts in the Bank Rate.

Some domestic inflationary pressures remain and may have eased a little more slowly than we expected last year, reaffirming the importance of taking a gradual approach to the withdrawal of monetary policy restrictiveness. Bank Rate is not on a pre-set path. With increased uncertainty and risks to inflation on both sides – from the near-term outlook to UK activity and inflation, and developments in the global economy – we must also proceed carefully, judging the evidence afresh at each meeting. Based on the committee’s evolving views of the outlook for medium-term inflation, a gradual and careful approach to the further withdrawal of monetary policy restraint is appropriate.”

Highlights of BOE statements and MPC outcome: 6th Feb’25

·       BOE cuts bank rate by 25 bps to 4.50%, as expected

·       The MPC voted by a majority of 7-2 to reduce the bank rate by 0.25 percentage points, to 4.5%

·       BoE guidance: A gradual and careful approach is appropriate

·       CPI stays above the 2% target for longer than seen in November

·       forecasts based on market path for rates at 4% by Q1 2028

·       Monitoring inflation persistence risks closely

·       inflation pressures are somewhat elevated

·       BoE forecast shows CPI in two years at 2.3% (November forecast: 2.2%)

·       BoE forecast shows CPI in one year at 3.0% (November forecast: 2.7%), based on market interest rates and modal forecast

·         BoE forecast shows CPI in three years at 1.9% (November forecast: 1.8%)

·       BoE forecasts unemployment rate in Q4 2025 4.5% (November: 4.1%}; @4 2026 4.7% (November: 4.3%); Q4 2027 4.8% (November: 4.4%)

·       MPC will ensure that the bank rate is restrictive for sufficiently long to return inflation to the 2% target sustainably

·       BoE estimates private sector wage growth ex-bonuses in Q4 2025 3.75% (November: 3.25%); Q4 2026 3.0% (November: 3.25%); Q4 2027 3.0% (November: 3.0%)

·       The monetary policy is restrictive following recent rate reduction, range of views on the degree of restrictiveness

·       Monitoring US tariffs closely, more protectionism would hurt the world economy

·       BoE sees inflation at 2.3% in Q1 2027, 1.9% in Q1 2028

 

Highlights of BOE Governor Bailey and other MPC comments in the presser/Q&A: 6th Feb’25

·       Taking a 'gradual and careful' approach to cuts

·       We expect to be able to cut the bank rate further

·       But we will have to judge meeting-by-meeting how far and how fast

·       The road ahead will have bumps

·       Behind the uptick in headline inflation stands a continued, gradual easing of underlying core inflationary pressures

·       Sees further moderation of underlying services CPI

·       This is the backdrop to our withdrawal of restrictiveness and our decision today

·       The coming rise in inflation is almost entirely due to factors not directly linked to pressures in the UK economy

·       We expect these factors to be temporary

·       Monetary policy cannot prevent such short-term influences on headline inflation.

·       Nor should monetary policy respond to factors that will fade by the time policy takes effect

·       A short-term pick-up in inflation introduces some further uncertainty into the near-term inflation outlook.

·       Reasonably confident that pick-up in inflation will be temporary

·       The labor market is cooling

·       Context is of weakening economic activity

·       The UK labor market is cooling, restrictive monetary policy is working

·       Evidence suggests firms are reluctant to pass on costs to consumer prices

·       Return to the CPI target is supported by economic slack

·       There is considerable uncertainty over the extent to which a weak economy is due to demand or supply

·       Consumers are more price-conscious and holding back on spending

·       It's unclear if GDP weakness is due to demand or supply

·       It's unclear what form global trade policies will take

·       We must judge in future meetings whether underlying inflation pressures are easing enough to allow further cuts

·       The bank rate is not on a pre-set path

·       It's important to a take gradual approach to easing

·       There are risks to inflation on both sides

·       There was quite a debate about the word "careful"

·       We should see 'gradual' and 'careful' together

·       We continue to use "gradual" because we still need to see disinflation take place.

·       We added 'careful' to reflect the uncertainty

·       You can conclude productivity has gotten much worse

·       It would be unusual for a poor productivity situation to remain

·       Uncertainty makes the disinflation path less assured

·       BoE's Bailey on government growth agenda: It will not come through quickly but we are supportive

·       The government is committed to long-term structural reforms that will help confidence

·       The government being commitment to long-term structural reforms will help confidence

·       I don't use the word 'stagflation'

·       We think the disinflation trend is in place

·       There was a bit of a debate about the world's "careful"

·       The effect of tariffs on inflation is more ambiguous

·       I wouldn't over-interpret moves in voting patterns

·       The view on rate path must be based on the economic fundamentals

·       We think the path for disinflation remains in place

·       Will be a bump in the road, won't have a lasting effect

·       Each member votes for what they think is best

·       On payroll tax rises: We haven't changed our view since November

·       When asked if the BoE is happy to cut rates as inflation rises: I expect the path for rates will be downward, but there is more uncertainty.

·       The cut to GDP growth forecast for 2025 is not about the budget really

·       Broad fragmentation would be very significant

·       The forecasts are not the only input for BoE rate decisions

·       We are currently not in a position to judge US policies

·       BoE's Lombardelli: You wouldn't expect to see long-term structural reforms affect our forecasts

·       BoE's Ramsden: UK factors accounted for only around a third of bond sell-off in January

·       BoE's Ramsden: UK gilt markets have been operating in a very orderly way

·       BoE's Ramsden: Gold stock held at the BoE has fallen by about 2% since the end of 2024

·       BoE's Ramsden: There has been strong demand for delivery slots for gold; we can meet that demand

·       BoE's Ramsden: It is an orderly process

·       BoE's Ramsden: All existing gold delivery slots are booked up

·       BoE's Ramsden: Economic developments justify a gradual approach

·       BoE's Ramsden: Developments in the economy have validated our approach of gradual rate cuts

UK Finance Minister Reeves said:

·       This interest rate cut is welcome news

·       However, I am still not satisfied with the growth rate

Bottom line:

Looking ahead, BOE may cut 2-3 times in 2025, totaling 50-75 bps rate cuts depending on the Fed’s actual action and Trump trade tantrum intensity. Like the Fed, the BOE has also brought down core CPI inflation to +1.4% targets (pre-COVID-Dec’19) and also the unemployment rate around 3.9% from the present 4.4% by 2026-27. But despite the relatively good relationship between the US and the UK, GBPUSD may come under pressure from the Trump trade war 2.0 narrative and also a stagflation-like scenario for the UK economy. Which is now a structural issue.

Technical trading levels: GBPUSD

Whatever the narrative, technically GBPUSD (1.24600) now has to sustain above 1.26000 for any recovery to 1.27300-1.28700 levels; otherwise sustaining below 1.25800, it may further fall to 1.25000-1.22800 and even 1.19800-1.18800 in the coming days.