The pound saw its biggest drop since October last year after BoE Governor Andrew Bailey suggested a quicker pace of interest rate cuts, signaling a shift in monetary policy.

Pound Drops Amid BoE’s Hint of Aggressive Rate Cuts

The British pound experienced its largest single-day drop since October 2023, falling over 1% against the U.S. dollar on Thursday. The currency’s sharp decline followed comments from Bank of England (BoE) Governor Andrew Bailey, who indicated that the central bank may accelerate its pace of interest rate cuts if inflationary pressures continue to ease.

Sterling dropped from $1.3268 to $1.3121 after Bailey’s remarks were published in an interview with The Guardian, extending its losses from the previous week when it traded above $1.34. The currency has been under pressure as investors reassess the BoE’s monetary policy trajectory, especially in light of high inflation and growing expectations of more aggressive rate cuts.

BoE’s Shift Toward Faster Rate Reductions

In his interview, Bailey acknowledged that the BoE’s rate-setting committee could adopt a more aggressive stance on lowering borrowing costs if the trend of declining inflation continues. The BoE held interest rates steady at 5% during its last meeting in September but signaled potential rate cuts as early as November.

Bailey’s comments challenged previous market expectations that the BoE would follow a more gradual approach to cutting interest rates compared to its counterparts at the Federal Reserve (Fed) and the European Central Bank (ECB). Market participants had anticipated that the BoE would maintain a slower rate-cutting cycle due to persistent inflationary pressures, especially in the services sector, which has remained elevated.

Following Bailey’s remarks, investors raised the probability of the BoE delivering two quarter-point rate cuts by the end of the year to 75%, up from a previous estimate of 50%. This shift in market sentiment reflects increasing confidence that the BoE will move more swiftly to ease monetary policy in response to improving inflation data.

UK Inflation and Services Sector Remain Key Concerns

Despite overall inflation holding steady at 2.2% in August, the BoE’s primary concern remains the services sector, where inflation rose to 5.6% in August, up from 5.2% in July. The services sector is a critical gauge of domestic price pressures, and its persistent inflationary trend had previously tempered expectations for significant rate cuts by the BoE.

However, Bailey expressed optimism that the broader cost-of-living pressures in the UK were not as entrenched as initially feared. This encouraged the BoE to consider a more activist approach in cutting rates if inflation continued to decline, potentially providing relief to businesses and consumers alike.

Bailey’s comments came amid the release of a BoE survey that highlighted ongoing price pressures in the UK economy. According to the survey, UK businesses expect wage growth of 4.1% over the next year, consistent with recent forecasts. Additionally, businesses anticipate raising prices by 3.6% over the same period, further supporting the notion that inflationary pressures remain embedded in the economy.

Impact on the Pound and Investor Sentiment

The pound’s sharp decline on Thursday reflects growing concerns among investors about the future path of UK monetary policy. Athanasios Vamvakidis, global head of G10 FX strategy at Bank of America (BofA), noted that Bailey’s comments were a departure from previous expectations that the BoE would adopt a slower pace of rate cuts compared to the Fed and the ECB.

“Given that inflation in the UK has been higher than in the U.S. and Europe, the market had priced in a shallower rate-cutting cycle,” Vamvakidis said. “But these comments suggest that the BoE could go faster.”

The unexpected shift toward potentially more aggressive rate cuts has led to a sharp drop in the pound, as traders adjust their positions in light of the new monetary policy outlook. While the BoE’s approach may provide much-needed relief for the economy, it also introduces uncertainty for investors, particularly those holding sterling-denominated assets.

Economic Outlook and Future BoE Policy Moves

The Bank of England’s policy shift comes as the UK economy continues to grapple with inflation and wage growth. According to a BoE survey, businesses expect wage growth to remain robust at 4.1% over the coming year, in line with recent trends. The survey also highlighted that businesses plan to raise prices by 3.6%, underscoring the continued inflationary pressures in the economy.

Rob Wood, an economist at Pantheon Macroeconomics, cautioned that these findings suggest that wage and price growth remain stubbornly high, which could limit the BoE’s ability to deliver rapid rate cuts. “The survey shows stubborn wage and price growth, supporting only gradual interest rate cuts,” Wood noted.

Despite these challenges, Bailey’s recent remarks indicate that the BoE is prepared to take a more proactive approach to monetary policy if inflationary pressures ease. Investors will be closely watching upcoming inflation data and BoE meetings to determine the pace and scale of rate cuts.

Sterling’s Performance in Context

The pound’s recent performance marks a significant reversal from its strength earlier this year when it traded above $1.34. Since then, concerns over inflation, wage growth, and monetary policy have weighed heavily on the currency. The prospect of faster rate cuts has exacerbated these concerns, leading to the largest single-day drop for sterling since October 2023.

Looking ahead, the pound’s trajectory will be influenced by both domestic economic conditions and external factors, including the actions of other central banks and global market dynamics. With the Federal Reserve and European Central Bank also navigating complex inflationary environments, the BoE’s approach to interest rate cuts will play a crucial role in shaping investor sentiment toward the pound.

Conclusion: BoE’s Rate Strategy Spurs Sterling Decline

Governor Andrew Bailey’s remarks on the possibility of more aggressive interest rate cuts have triggered a sharp decline in the pound, reflecting growing uncertainty about the BoE’s monetary policy direction. While the BoE remains focused on easing inflationary pressures, particularly in the services sector, the pace of future rate cuts will depend on the broader economic outlook.

As investors digest the latest developments, the pound’s performance will likely remain volatile in the short term, influenced by both domestic and global factors. With inflation showing signs of improvement, the BoE’s next moves will be closely scrutinized as market participants recalibrate their expectations for UK monetary policy.