BOE’s Pill Prompts Rate Adjustment Without Much FX Impact

The three-month SONIA futures experienced a robust increase of approximately 10 basis points yesterday. This surge came in the wake of remarks made by the Chief Economist of the Bank of England, Huw Pill, on Monday evening. These comments have fuelled growing speculation that the Bank of England may reduce its primary interest rate by the middle of the next year. The central bank's shift in communication can be summarized as follows: they initially emphasized the necessity of rate hikes, then stressed the need for rates to remain elevated for an extended period, followed by an emphasis on the potential for future rate cuts. This has now evolved to the point where rate cuts might become more imminent.

This shift has occurred more swiftly than anticipated, particularly with Pill's recent comments suggesting a move towards considering rate cuts. The Bank of England may feel more assured in making such statements as UK inflation is expected to align more closely with global trends. In particular, the 80% increase in the OFGEM utility price cap in October 2022 will no longer factor into the annual calculations when the October CPI data is released next week on November 15th.

With the potential for the annual CPI rate to drop below 5.0% next week, the Bank of England is likely to shift its focus towards economic growth and activity, a departure from their stance just a few months ago. This change in focus suggests a more dovish stance from the Bank of England as we approach the end of the year and enter 2024. Despite the adjustments observed yesterday, there is still room for further reductions in yields compared to other major economies. The OIS curve currently indicates that approximately 40 basis points of rate cuts are now factored in by September 2024, while the European Central Bank's pricing stands at 66 basis points, and the Federal Reserve's pricing is at 62 basis points.

It's worth noting that the US economy displays greater resilience compared to the UK, which should provide some encouragement to the Bank of England. Additionally, there is clear evidence of a decreasing demand for labour, as indicated by PAYE employment data, which shows three consecutive monthly declines in employment. This softening in the labour market has led to a slowdown in wage growth, as evidenced in the same PAYE dataset. The annual growth rate in median pay has decelerated from 7.6% in August to 5.7% in September, and the 6-month annualized growth rate has slowed from 6.7% to 4.2%—the slowest pace since August 2020. The continued evidence of such wage growth deceleration is crucial for the sustainability of this early shift in communication.

While the comments from Huw Pill this week have not resulted in a broader underperformance of the GBP, the downside risks persist for the time being.

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