Bank of England keeps rates at 5%, propels pound to over 2-year highs

The Bank of England (BoE) kept its Bank Rate steady at 5% during the 19 September meeting, in line with economists’ expectations.

The decision to maintain the policy rate was backed by a clear majority, with eight members voting in favour, while only one member, Swati Dhingra, advocated for a 25 basis point reduction.

The Committee also voted unanimously to reduce the stock of UK government bond purchases held for monetary policy purposes, financed by the issuance of central bank reserves, by £100 billion (€84 billion) over the next 12 months, bringing the total to £558 billion (€469 billion).

In August, the BoE had lowered rates by 25 basis points, as annual inflation fell to 2% in July.

Despite pressure on the eve of the meeting, following the Federal Reserve’s sharp 50 basis point rate cut a day earlier, UK policymakers opted to keep rates unchanged amid the “absence of material developments.”

“Inflation has eased, the economy is evolving as forecast. A gradual approach to removing policy restraint remains appropriate,” the BoE stated.

Headline economic growth is expected to return to its underlying pace of around 0.3% per quarter in the second half of the year.

Based on a broad set of indicators, the Monetary Policy Committee (MPC) judged that the labour market continued to loosen but remained tight by historical standards.

The UK’s annual inflation rate rose to 2.2% in August, while core inflation—which excludes energy and food costs—rose to 3.6%, slightly surpassing the forecast of 3.5%.

The BoE anticipates annual inflation to rise to around 2.5% towards the year’s end, as the impact of last year’s declines in energy prices fades from the annual comparison.

Regarding future policy, UK policymakers emphasised that decisions would be made on a meeting-by-meeting basis.

Market reactions

The British pound spiked to 1.33 against the US dollar, reaching levels not seen since early March 2022, in the aftermath of the Russian invasion of Ukraine.

This rally was propelled by the widening interest rate divergence between the BoE and the Federal Reserve.

Sterling also strengthened against the euro, hitting 2-year highs. The EUR/GBP exchange rate fell below 0.84, on track to close at its lowest levels since August 2022.

The 2-year gilt yield remained steady at 3.90%, now yielding 30 basis points more than the equivalent 2-year U.S. Treasury yield and 165 basis points more than the 2-year German Schatz yield.

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UK interest rate futures now indicate a 66% chance of a BoE rate cut in November, down from fully pricing in a cut before the decision.

The FTSE 100 slightly dipped following the decision but maintained gains for the session, up 0.7%.

The top performers of the day included Burberry Group, up 5.4%, followed by miners such as Glencore, Anglo American, Fresnillo, Antofagasta, and Rio Tinto, all up between 3.4% and 4.8%.

European stocks also rallied on Thursday, buoyed by the Federal Reserve’s large interest rate cut on Wednesday.

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The Euro Stoxx 50 gained 1.8%, eyeing its strongest session in over a month. Top performers included Dutch chipmaker giant ASML Holding, up 3.6%, Saint-Gobain, up 3.4%, LVMH, up 3.3%, BMW, up 3.3%, and Airbus, up 3.1%.

Among country stock indices, the OMX Stockholm 30 led the gains, rising over 2%, followed by the Paris CAC 40, up 1.9%.