BoE Review: GBP hit by dovish hold leaving March in play
- Macro view: The BoE held Bank Rate at 3.75% in an unexpectedly tight 5–4 vote that clearly opens the door to a cut at the next meeting in March. Policymakers are notably more confident in the disinflation process with the updated projections showing inflation returning to target swiftly in Q2 and then remaining there or thereabouts. Governor Bailey will still remain the key swing voter on a divided MPC. But external member Mann has also now emerged as an additional wildcard who could also tilt the balance, further raising the likelihood of a cut in March. Focus will be firmly on the two sets of labour market data released before the next policy announcement. We maintain our call for a terminal rate of 3.25%, with risks tilted towards an extra cut this year.
- Markets view: The dovish repricing of BoE rate cut expectations and renewed concerns over political risks in the UK are triggering a quick reversal of GBP gains from early this year. We continue to hold a long AUD/GBP trade recommendation.
Macro view: A dovish hold leaves March in play
The BoE is increasingly confident in the disinflation process
A quiet BoE meeting seems to be a rare occurrence in recent times and today’s decision to leave rates unchanged at 3.75% came with an expectedly tight 5-4 vote. The door looks to be wide open to a rate cut at the next meeting in March as policymakers have seemingly gained confidence in the inflation outlook.
The BoE’s updated projections moved the near-term inflation trajectory markedly lower, reflecting both the impact of the known Budget measures and expectations for cooling price pressures more broadly. Headline inflation is now expected to fall to 2.1% in April and back to target by June. Over the medium-term, the BoE now expects sub-target headline inflation during most of 2027 and into 2028. The quarterly unemployment rate is now seen as peaking at 5.3%, from 5.1% previously.
Meanwhile, the BoE’s Agents Survey of businesses, flagged by various MPC members in December, was also dovish, at the margin. It shows planned pay settlements of 3.4% this year which is slightly below expectations and not far off the figure of 3.25% that the BoE noted today as target consistent.
The policy guidance was also tweaked from “Bank Rate is likely to continue on a gradual downward path” to “Bank Rate is likely to be reduced further” – i.e. “gradual” was removed – which increases the BoE’s flexibility to act next time out.
All told, this meeting feels like something of a recalibration moment. We argued after the last meeting (here) that the BoE was likely being too cautious in the context of clear labour market slack and would have to adjust its approach this year – and that seems to be the case now. What is somewhat surprising is the timing of the apparent shift given the lack of obvious data signals in recent weeks.
While labour market data continues to show clear evidence of slack, there was essentially no progress on underlying inflation in the CPI numbers for December and activity data was somewhat firmer than expected with a marked uptick in the January PMI.
Nonetheless, both Ramsden and Breeden joined perma-doves Taylor and Dhingra in calling for a back-to-back cut, citing increased confidence in the disinflation process. It’s worth noting that Ramsden’s dissenting votes last year were good leading indicators for MPC rate cut decisions at subsequent meetings.
Fragmentation on the MPC is set to persist given varying views on where the neutral policy setting lies as well as wariness around making a policy mistake that could undermine credibility. Given that, Bailey will remain the key swing voter that could tip the balance towards a cut. However, Mann’s vote is now an additional wildcard factor. The external member, who characterises herself as an “activist” policymaker, noted that “the appropriate time for a cut” may have moved closer.
Looking ahead, we stick with our call for a terminal rate of 3.25% (i.e. two more cuts in 2026), with risks tilted towards an additional cut. While there was a clear dovish shift today, the timing of the next move will still hinge on the data. It will be interesting to see if the bounce in the PMIs reverses in February as the post-Budget boost unwinds. More critically, the BoE will have two more sets of labour market data by the next meeting. With the BoE acknowledging that further easing is “likely”, it may not take much in the way of further declines in employment or cooling private sector wage growth to tilt the balance to a vote to ease next time out.
The BoE has greater confidence in the disinflation process
The UK economy has been shedding jobs in recent months
Markets view: Dovish hold hits GBP alongside political risks
Recent gains were built on shaky foundations
The GBP has weakened sharply following today’s much more dovish‑than‑expected BoE policy update. After briefly touching a low of 0.8613 yesterday, EUR/GBP has since rebounded back above the 0.8700 level. This marks a sharp reversal for the GBP, which had been steadily strengthening against the EUR since last autumn, when EUR/GBP reached a high of 0.8865 on 14th November in the run‑up to the Budget. In recent months, the pound had been supported by fading fiscal and political risks in the UK and by a scaling‑back of BoE rate‑cut expectations. We had even pushed back our own forecast for the next BoE rate cut from March to April (click here).
However, it now appears we were premature in abandoning the possibility of another rate cut as early as next month. Today’s decision to keep rates on hold was much closer than anticipated, with a narrow 5–4 split. Moreover, two MPC members who voted to hold, Governor Bailey and Catherine Mann, signalled that they could potentially support a cut at upcoming meetings, lowering the hurdle for a move in March. Typically hawkish member Mann noted that “new analysis and current developments have moved the appropriate time for a cut in the Bank Rate closer,” adding that she looked forward to incoming assessments of surveys and data ahead of future decisions. Governor Bailey similarly stated that “risks from inflation persistence appear to have continued to reduce. I therefore see scope for some further easing of policy. This does not mean that I expect to cut Bank Rate at any particular meeting. I will go into the coming meetings asking whether a cut is justified.”
In response, UK rate markets have repriced markedly: investors now expect around 16bps of cuts by the March MPC meeting, compared with just 5bps yesterday. For the year as a whole, markets continue to price only two further rate cuts.
The dovish repricing of BoE expectations has benefited our long AUD/GBP recommendation (click here), which is now moving closer to our profit target of 0.5180. Yield spreads between Australia and the UK have widened further this week after the RBA raised rates and left the door open to additional tightening. By contrast, we still anticipate two more BoE cuts this year, with a possible third if the UK labour market turns out weaker than expected and if inflation and wage pressures slow more sharply.
At the same time, the GBP has come under additional pressure from renewed political uncertainty in the UK. Prime Minister Keir Starmer’s position remains fragile and has been further undermined by his past decision to appoint Peter Mandelson as the United Kingdom’s Ambassador to the United States. The Epstein‑related scandal surrounding Mandelson has triggered fresh speculation about a potential leadership challenge ahead of the local elections in May.
EUR/GBP has been testing support from 200-day moving average
Source: Bloomberg, Macrobond & MUFG GMR