Disappointing Central Bank Announcement, GBP/USD Threatened

The British central bank's (BoE) rate hike decision was followed by more dovish rhetoric, triggering a sell-off in the pound sterling.

The pound sterling was roiled in trading Thursday, as the British central bank's (BoE) interest rate hike decision was followed by more dovish rhetoric. GBP/USD slumped to around 1.3140, in line with the Fed's more hawkish stance than the BoE, although sterling was still ahead versus the euro and Japanese yen when news was written early in the European session on Friday (18/March).

GBP/USD Daily chart via TradingView

The results of yesterday's Monetary Policy Committee (MPC) meeting showed that 8 members supported a 25 basis point increase in interest rates, and only 1 member recommended a 50 basis point increase. The BoE MPC's final decision to raise interest rates from 0.50% to 0.75%, was accompanied by a series of more cautious guidance regarding further rate hikes in the future.

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The BoE says it still needs to raise interest rates in the coming months, but cautions that market expectations for rates reaching 2.0% by the end of this year are too extreme. The BoE's stance then triggered a slump in the pound sterling across other currencies.

"The sell-off in GBP reflects initial disappointment among market participants that the BoE's policy reforms were not as hawkish as previously thought," said Lee Hardman, currency strategist at MUFG.

Prior to the announcement of the BoE's decision, the market had priced in a further rate hike of a total of 134 basis points until the end of 2022. However, the number slumped to just 123 basis points this Friday morning.

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The BoE admits that the Russia-Ukraine war could increase the inflation rate, possibly up to around 8% in the second quarter and could even increase again in the following period. At the same time, they expressed concern that too high inflation would undermine individual purchasing power and threaten the health of the UK economy. Meanwhile, the very high inflation rate is likely to fall rapidly in the medium term after pressure from abroad subsides. These considerations make the BoE reluctant to plan for another aggressive rate hike cycle.

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Chris Beauchamp, IG's chief market analyst, said, "Nobody can accuse the BoE of rushing, but even the tempo of the recent (rates) hikes seems too fast. So the pound is losing some of its advantages against a variety of currencies, and could struggle in the short term as the market examines a more dovish (BoE) tone."

The news from the Russian-Ukrainian battlefield is still confusing. Mass media reports reveal that the two sides are discussing a type of neutral status for Ukraine, which is similar to that of Austria and Sweden (Austria and Sweden are members of the European Union that are outside the NATO military alliance -ed). Russia appeared to welcome the idea, while Ukraine's chief negotiator said such a status would provide international security guarantees for Kyiv. However, despite the progress in the negotiations, Russia continues to bombard cities in Ukraine.