While the Bank of England’s Quarterly Inflation Report did reflect a reduction in the bank’s growth forecast and BOE Governor Mervyn King forecasted that the economy would slow “sharply,” the underlying sentiment of the release suggested that future rate cuts may come at a more leisurely rate than the markets are anticipating.
Indeed, the Report said that CPI would overshoot the BOE’s 2 percent target based on expectations that the overnight lending rate would be cut by an additional 75bp to 4.50 percent by the end of the year. Furthermore, the BOE forecasted that inflation would reach “around” 3.1 percent – the level at which Governor King would be forced to write a letter to Chancellor of the Exchequer Alistair Darling explaining how the bank planned to bring CPI back to target. Contrary to what the markets took from the BOE’s most recent policy statement, inflation does remain a concern for the MPC and will likely prevent the bank from slashing rate aggressively. In fact, given the BOE’s indications that CPI would overshoot their target if they reduced rates in line with expectations – approximately three times by 25bp before year end – the comments suggest that Governor King is only prepared to implement one or two more rate cuts, neither of which are likely in March.
The British pound has rallied on the news, with GBP/USD testing 1.9650 given the reduction in rate cut expectations. We discussed the potential for such a move in yesterday’s DailyFX Cross Market Reactions.
For the full text of the Bank of England’s Quarterly Inflation Report, click here.