The release of the Bank of England’s Quarterly Inflation Report triggered a 300+ pip selloff in the British pound on Wednesday morning, as the central bank offered a bleak picture of UK economic conditions.
Indeed, in the report, the BOE revised their growth projections sharply lower for 2008 – 2009 and even said that GDP could be negative for one or two quarters. Furthermore, while CPI forecasts were revised up toward 5 percent through the end of 2008, the inflation outlook was downgraded significantly from 2009 – 2011. What does this mean for interest rates in the UK? Currently, overnight index swaps are pricing in almost 75bps worth of rate cuts over the next 12 months, compared to approximately 50bps in recent days. However, BOE Governor Mervyn King prepared the markets for the worst as he said the UK economy faces a “difficult, painful adjustment,” suggesting that the head of the central bank will seek to leave rates steady through the end of the year – despite the risk of recession – in an attempt to cool inflation. Once we hit 2009 and CPI starts to pullback, though, interest rates are likely to be cut rapidly. In the near-term, GBP/USD could consolidate above Wednesday’s lows near 1.8650, but I still believe that the pair will ultimately move down for a test of 1.85.
