Pound slumps as City cuts Bank of England interest rate bets after shock inflation fall

Pound sterling today has tumbled sharply in response to markets reining in their expectations for further interest rate hikes from the Bank of England.

Britain’s currency shed nearly one per cent against the US dollar, its largest fall in months, to buy $1.29. It was down a similar amount against the euro at €1.15.

The slide has pegged back the pound’s 2023 rally, which had taken its gains against the dollar before the release of a better-than-expected batch of inflation data today to around eight per cent. It was also up sharply against its European peer.

Office for National Statistics (ONS) figures out this morning revealed the rate of price growth in the UK fell faster than expected in June, down to 7.9 per cent from 8.7 per cent in May.

Core inflation thinned to 6.9 per cent, also below market expectations, while services price growth dropped to 7.2 per cent.

A stronger ebbing in price pressures compelled traders to climb down from aggressive bets on how high the Bank will lift interest rates at its next meeting and over the next 12 months.

The City now thinks Bank governor Andrew Bailey and the rest of the nine-strong Monetary Policy Committee (MPC) will bump borrowing costs up 25 basis points on 3 August and eventually pull them up to a peak of 5.75 per cent.

Before the release of the ONS’s numbers, a 50 basis point jump was priced in next month and a summit of 6.25 per cent.

June’s inflation is likely to “tilt the balance towards a 25 basis point (bps) hike rather than 50bps,” Paul Dales, chief UK economist at consultancy Capital Economics, said.

It means the lengths the Bank is willing to go to tame inflation will be only slightly sharper than the US Federal Reserve’s efforts. Markets think Fed chief Jerome Powell and co will back a final rate increase of 25 basis points next week, taking the federal funds rate to 5.25 per cent to 5.5 per cent.

European Central Bank officials, who also meet next week, are projected to beef up interest rates at least one more time from their current level of 3.5 per cent.

Lower potential returns on UK assets meant traders sold the pound today, pushing it lower.

UK debt rates also crumbled due to traders demanding higher prices for bonds to account for lower Bank rate projections. 

Two-year gilt yields skidded down 20 basis points to 4.8 per cent, while the return on the 10-year UK government bond fell 16 basis points to 4.1 per cent. Yields and price move inversely.

There is likely to be relief on the horizon for mortgage holders and those looking to get on to the housing ladder.

A reduction in market rate expectations – measured by the overnight index swap (OIS) rate – should compel banks to cut rates on home loans after they surged to their highest level in around 15 years this month. Banks price their mortgages on the OIS rate, which is poised to shift lower.

Data firm Moneyfacts said recently the rate on the average rate on the two-year mortgage topped their post-mini-budget levels at 6.6 per cent.