Bank of England keeps interest rates on hold, British pound rally in more than two years

LONDON – The Bank of England said on Thursday it would keep interest rates steady after its initial cut in August, even after the US Federal Reserve opted to cut the jumbo rate earlier in the day.

The Monetary Policy Committee voted 8 to 1 in favor of retention, with dissenting members voting for a 0.25 percentage point cut.

A “gradual approach” to monetary easing remains appropriate, while services inflation remains “elevated”, the committee said. The UK economy, which has returned to growth but slowed this year, is expected to return to an underlying pace of around 0.3% per quarter in the second half, it added.

The British pound was strengthened by both announcements, trading up 0.72% to $1.3306 against the US dollar at 12:10 pm London time on Thursday. This was the highest rate since March 2022, according to LSEG data.

Meanwhile, global equity markets rose on Thursday, with the pan-European Stoxx 600 index up 1.4%.

Also closely watched on Thursday is the BOE's annual announcement on the pace of quantitative tightening (QT). The central bank has voted to reduce its bond stock – known as gilts – by £100 billion ($133 billion) over the next twelve months through active sales and bond maturities.

This amount was in-line with the previous period, contrary to some expectations for an acceleration of the program. The BOE's balance sheet swelled during the pandemic as it sought to stimulate the economy, before it reversed course and began QT in February 2022.

The BOE now incurs losses on its QT program, subsidized by the taxpayer, because they are being sold for less than they were bought for. However, BOE Governor Andrew Bailey argues that the central bank needs to operate QT now to leave room for further quantitative easing or other actions in the future.

The MPC was evaluating a mixed bag of data to make its rate decision, with headline inflation consistently hovering close to its 2% target but rising prices in services – which account for around 80% of the UK economy – ticking in at 5.6% in August. Wage growth in the UK cooled to a more than two-year low in the three months to July, but was relatively high at 5.1%.

The BOE confirmed expectations for a hold even after the US Federal Reserve cut its own rates in the current cycle with a 50 basis point cut on Wednesday. Many strategists had expected a 25 basis point decline at the September meeting, although market pricing this week pointed to a more aggressive option than 50%.

Fed Chair Jerome Powell said at a press conference that the central bank is “trying to achieve a situation where we want to restore price stability without the painful increase in unemployment that sometimes comes with this inflation.” Recent US labor market data has raised concerns about the extent of the recession in the world's largest economy.

The MPC's decision was likely locked in around midday on Wednesday before the Fed's announcement, but central bankers around the world will now assess what the move means for global economic growth and financial conditions.

Kyle Chapman, foreign exchange analyst at Ballinger Group, said the BOE delivered a “more decisive and more hawkish vote than expected” with an 8 to 1 vote split, supporting gilt yields and lifting sterling.

“This is a cautious decision that reflects the fact that the Bank of England is not in as fortunate a position as the Federal Reserve when it comes to inflation… That said, this meeting reads like a move towards a cut in November, and then a continued quarterly pace.”

Meanwhile, global equity markets rose on Thursday, with the pan-European Stoxx 600 index up 1.35%.

The Bank of England cut its key rate to 5% from 5.25% in August by a 5 to 4 vote, and was widely expected to remain there until its next meeting in November.

Frédéric Ducroset, head of macroeconomic research at Pictet Wealth Management, said of the QT program that the Bank of England was “stuck between a rock and a hard place and that's because of their choices in the past” and because it was the only central bank in the world that was recording such losses.

The UK's new Labor government is due to present its first budget in October. Extending passive and active QT over the next year “will create problems for fiscal policy, at least it won't make the government's job any easier,” Ducroset told CNBC's “Street Signs Europe” shortly before the decision.

“Or you don't, and then you feel like you're not really independent of government, you do more damage, and you have to manage that over time,” he said.