Traders raise bets on Bank of England interest rate cut

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Traders have stepped up their bets that the Bank of England will cut interest rates on Thursday, as markets prepare for aggressive moves by the US Federal Reserve to lower borrowing costs.

Investors are now pricing in an almost 40 per cent probability that the UK central bank will cut rates by 0.25 percentage points. That compares with a roughly 20 per cent chance the market was ascribing to a cut late last week.

While keeping rates at 5 per cent is still seen as the more likely outcome for the BoE, bets on a cut have increased as traders increasingly expect a jumbo Fed cut of 0.5 percentage points on Wednesday.

The recent strength of sterling — which is trading close to its highest level against the dollar since 2022 — may make it harder for the BoE to avoid cutting rates on Thursday if the Fed opts for a half-point cut, since a stronger pound could act as a further brake on growth.

“Whilst not part of the bank’s mandate, if the BoE didn’t follow [other central banks] with rate cuts, it could cause an unwelcome appreciation in the pound,” said Ross Yarrow, a managing director at investment bank Baird.

He added that this “would hurt the UK’s international competitiveness as an exporter”.

Economists at Citi said they thought UK policymakers should cut rates this week because of “soggy summer activity data, alongside continued moderation in labour quantities, wage growth and services inflation”.

The BoE cut rates for the first time in more than four years last month from a 16-year high of 5.25 per cent. The European Central Bank has already delivered two quarter-point cuts this year but the Fed has yet to reduce rates in this cycle.

Investors say the UK’s inflation data for August, which will be published on Wednesday, will also play a big role in determining if the BoE cuts rates this week. Economists polled by LSEG expect headline annual inflation to remain at 2.2 per cent.

“If the UK CPI surprises to the downside tomorrow and the Fed cuts by 50 basis points, the risks rise that the BoE cuts rates by 25 basis points this week,” said Ranjiv Mann, senior fixed income portfolio manager at AllianzGI.

Wage pressures have also eased in recent months. Data last week showed that the UK economy stagnated for a second consecutive month in July, while economists had expected growth of 0.2 per cent.

“The UK has a productivity problem and a pretty serious one . . . We’re in a situation where the UK needs structurally lower interest rates,” said Steve Ellis, global chief investment officer for fixed income at Fidelity.

But most traders expect that persistent UK services inflation, which is closely followed by policymakers, will limit the pace of BoE rate cuts. Economists forecast services inflation to have risen from 5.2 per cent in July to 5.5 per cent in August.

Markets are pricing in just over 1 percentage point of cuts in the UK by March next year, compared with close to 2 percentage points of cuts for the Fed.

The BoE only narrowly voted for last month’s rate reduction, in a five-to-four decision, and key policymakers have not been preparing the ground for another move this month.

In the last meeting, BoE governor Andrew Bailey shared the majority view that sustainable declines in inflation were “almost baked in” as global price shocks unwind.

However, four MPC members continued to judge that services inflation and wage growth remained too strong for comfort. As a result, a big shift would be required for a majority to vote for a cut.

“There was hardly any guidance that would indicate they are willing to cut,” said Peter Schaffrik, chief European macro strategist at RBC Capital Markets.