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Sterling Falls as UK Inflation Slows, Raising Possibility of BoE Rate Hike Pause

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Sterling Falls as UK Inflation Slows, Bank of England May Pause Rate Hikes

Sterling reached its lowest point since late May, while UK government bonds and stocks rallied on Wednesday after data showed that inflation slowed more than expected in August. This raised the possibility that the Bank of England (BoE) may put a hold on rate hikes this week.

According to Reuters, British annual consumer price inflation fell to 6.7% last month. Economists had predicted that the consumer price index (CPI) would rise to 7.0% from July’s 6.8%. This forecast was based on the assumption that fuel prices and the tax on alcoholic drinks would increase.

Following the release of this data, sterling fell by 0.23% to $1.2363, reaching its lowest point since May 30. This decline came as investors tried to withdraw their bets that the BoE would raise interest rates again on Thursday.

Traders now believe that there is a 60% chance that the Bank will leave rates unchanged, in comparison to just 20% on Tuesday, according to pricing in derivatives markets. They now see a 40% chance of a 25-basis-point increase to 5.5%, which was considered almost certain just a month ago.

The fall in sterling prompted investors to rush into British bonds, resulting in a 14 basis-point slide in interest rate-sensitive two-year gilt yields to 4.86%. The benchmark 10-year Gilt yield also fell by 9 basis points to 4.254%, reaching its lowest point since late July.

Goldman Sachs further bolstered the bullish sentiment in UK bond and equity markets by stating that it believes the BoE has already finished hiking rates.

Following these developments, the FTSE 100 stock index rose by 0.8% and the FTSE 250 index of mid-sized companies surged by 1.44%. Both indices outperformed the 0.63% rise in the pan-European STOXX 600 gauge.

Goldman economists, led by Sven Jari Stehn, said in a research note, “The August inflation print surprised meaningfully to the downside, particularly on core and services inflation.” They added, “Combined with their recent dovish commentary, we now expect the MPC to keep Bank Rate unchanged tomorrow and lower our forecast for the terminal policy rate to 5.25%.”

However, while many analysts predict that the BoE will pause rate hikes, some still expect one final increase on Thursday. Consumer price inflation is still significantly higher than the target rate of 2%, making the UK the country with the highest rate of inflation among major economies.

Jane Foley, senior FX strategist at Rabobank, said, “It remains our house view that a rate hike is likely, though certainly the odds that a pause will follow have risen.” She also suggested that the pound could receive support from investors now that inflation is slowing faster than anticipated, which would be positive for the UK economy.

Kim Crawford, global rates portfolio manager at JPMorgan Asset Management, stated that the Bank of England’s decision is more finely balanced as activity data weakens more clearly. However, she warned that a pause at this meeting could backfire, as wage growth continues to surprise on the upside.

Overall, with inflation slowing and uncertainty surrounding rate hikes, the Bank of England faces a challenging decision on Thursday.

More detail via Yahoo Sports here… ( Image via Yahoo Sports )

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