Yahoo Finance Bank of England interest rate hike sparks pound and gilts volatility
The pound suffered trading volatility on Thursday as investors weighed up news that the Bank of England (BoE) had hiked interest rates by 0.5%, and what this could mean for the British economy.
After the noon announcement it made a knee-jerk spike of 0.4% against the dollar (GBPUSD=X), to more than $1.28, as higher interest rates mean the pound is worth more abroad. However, the currency pared back its gains amid recession fears.
“Rather than sending sterling soaring, today’s bigger than expected jump in interest rates has left the pound like a rabbit in the headlights,” Simon Phillips, managing director at travel money firm No1 Currency, said.
“Sterling has been fluctuating wildly as global investors decide whether buying pounds is still a good bet with so much uncertainty surrounding the UK’s economic prospects.
“Nevertheless the pound is still hovering close to a 14-month high against the US dollar, and this week it hit its highest level against the euro since last August.”
He added: “But exchange rates can fluctuate a lot at times like these. So if you are planning a trip abroad in the coming weeks or months, it could make sense to pick up some foreign currency now rather than leave it all to the last minute.”
Read more: Why the Bank of England may have to create a recession
Meanwhile, Fiona Cincotta, senior financial markets analyst at City Index, warned that looking ahead to the end of the year the pound would be weaker
“The outlook for sterling is weaker across the year. As the likelihood of a recession rises, the pound is likely to come under pressure,” she said.
Sterling was also flat against the euro (GBPEUR=X), which is worth 86p.
The volatility came as members of the Monetary Policy Committee (MPC) voted 7-2 to increase the bank rate to 5%, its highest level in 15 years, in a bid to combat rising inflation and the ongoing cost-of-living crisis.
Financial markets are now betting on at least another four 25bps hikes still to come, making for a terminal rate of 6% by the end of the year.
"We’ve raised rates to 5% following recent data which showed that further action was needed to get inflation back down," Andrew Bailey said on Thursday.
"The economy is doing better than expected, but inflation is still too high and we’ve got to deal with it.
"We know this is hard – many people with mortgages or loans will be understandably worried about what this means for them. But if we don’t raise rates now, it could be worse later.”
Read more: Interest rates: When will UK’s mortgage misery end?
Shorter-maturity UK gilt yields also rose on the back of the news, while rates on longer bonds such as 10-year gilts fell due to bets that the tightening cycle would slow the economy.
The yield on two-year UK bonds, which is the rate the government promises to pay holders of its debt, increased two basis points to 5.05%, while the coupon on 10-year gilts dipped almost five basis points to 4.35%.
“Although the Bank warned of further tightening ahead, it shied away from using language that would signal a repeat of today’s bold move and confirmed data dependency,” Andy Burgess, fixed income investment specialist at Insight Investment, said.
“The markets’ initial reaction was that more now means less later, with UK gilt yields rallying on the announcement.”
Muhammed Demir, head of capital markets at Swiss Finance Corporation, added: “The Bank of England needs to face up to the fact that the UK is drifting aimlessly into emerging market territory.
“If there are no structural improvements to the UK economy, we will continue to see rates rising, inflation sticky and anaemic economic growth. This will inevitably lead to a weaker pound in the long run.”
Watch: How does inflation affect interest rates?
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