Thursday, 10 May 2018

Sterling down, bonds rise as Bank of England cuts inflation, growth forecast

LONDON (Reuters) - Sterling reversed earlier gains and fell to the day’s lows on Thursday after the Bank of England kept interest rates on hold as widely expected, but cut inflation and growth projections for this year and the next.

Before the decision, sterling was up as much as 0.4 percent at $1.3618 but fell to trade 0.2 percent lower on the day at $1.3521, not far away from a four-month low of $1.3485 hit on Tuesday.

While expectations of a rate hike have fallen rapidly in recent days after a run of weak data and cautious comments from policymakers, the cut in inflation and growth forecasts weighed on currency markets.

The 2-year gilt yield fell around 2 basis points after the decision to 0.81 percent.

Short sterling interest rate futures rose 3 to 4 ticks across 2018 and 2019 contracts, indicating a shallower path for future BoE interest rate rises.

“I think the fact you have as expected downgrades to growth forecasts and more importantly perhaps, downgrades to the inflation story for 2019 and 2020 period, has probably been a influence on sterling,” said Sarah Hewin, chief economist for Europe at Standard Chartered in London.

Britain’s blue chip FTSE 100 index cut losses to trade flat in percentage terms after the BOE kept rates on hold.

In sharp contrast to overwhelming expectations a few weeks ago that they would raise rates, BoE policymakers voted 7-2 to keep them at 0.5 percent.

That was in line with forecasts from economists polled by Reuters in the past week.

Governor Mark Carney said the BoE - which cut its 2018 growth prediction and trimmed its inflation forecasts - expected growth would gain speed again. It was sticking to its message that rates would probably need to rise - for only the second time in over a decade - once that recovery was clear.

“What’s the sensible thing to do? Do you act now or do you wait to see evidence that momentum is re-asserting,” Carney told reporters.

Investors slightly pushed back their bets on when rates would rise, and sterling slid close to a four-month low against the dollar while the yield on two-year British government bonds edged down.

Rate futures showed less than a 50 percent chance of a hike in August, the next time the BoE updates its forecasts.

“It looks like the 2018 rate hike has been delayed not cancelled,” Fitch Ratings chief economist Brian Coulton said.

Britain’s economy grew more slowly than most of its peers last year after a Brexit-driven jump in inflation hit consumer spending power and some businesses delayed long-term investment.

Growth slowed even more sharply in early 2018 on a mix of unusually icy weather and headwinds from Britain’s impending European Union exit.

Recent data “had been consistent with a temporary soft patch...,” most of the BoE’s rate-setters said. “(But) there was value in seeing how the data unfolded over the coming months.”

Despite weak growth, the BoE sees the need for rate hikes because it thinks the economy could overheat due to long-term weak productivity and lower immigration driven by Brexit.

Carney said in February that rates might go up sooner than the BoE had previously suggested, and was asked by a reporter on Thursday about the description of him as an “unreliable boyfriend” - first used by a British lawmaker because of his previous signals about when rates might rise, which misfired.

“The only people who throw that term at me are in this room,” Carney told the news conference.

Policymakers Ian McCafferty and Michael Saunders, who again voted for a rate rise, agreed the weak growth so far this year reflected “temporary or erratic factors”, but said delaying a rate hike risked more abrupt tightening later on.

The BoE said the weakening of inflation was due to a faster fading of the impact of sterling’s plunge on import prices, and domestic inflation pressures continued to rise.

Inflation was seen dropping to 2.1 percent in a year’s time, and returning to target a year later but only if interest rates rose by 25 basis points about three times over three years, as markets expect.

The BoE said the economy would grow by 1.4 percent this year, down from the 1.8 percent it predicted in February, with slowing consumer lending and a sluggish housing market creating greater-than-usual uncertainty about consumer demand.

For 2019 and 2020, it predicted growth of 1.7 percent, down from 1.8 percent in its February forecasts.

Reporting by Tom Finn, David Milliken and William Schomberg

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