Bank of England to dig deeper as pound sits in precarious territory

(Alliance News) - The Bank of England may considerably quicken the pace of interest rate hikes in a bid to support a beleaguered pound, which is edging ever closer to level-pegging with the dollar.

That's according to Dutch bank Rabobank, which fell short of a pound-dollar prediction, but retained a USD1.08 "target".

The pound traded below the USD1.11 mark on Friday afternoon, fetching USD1.1026 and down considerably from the USD1.1386 it fetched a week ago. At the start of the year, the pound bought around USD1.35.

"By the time that the BoE had announced an as-expected 50 bp rate hike yesterday, it was likely that the market consensus had decided that there was very little that the [Monetary Policy Committee] could do to turn around the short-term prospects for GBP," Rabobank analysts commented.

The BoE on Thursday lifted the key bank rate by 50 basis points to 2.25%, its second successive half-point hike.

There were some that believed the central bank would pick up its pace of tightening with a 75bp rate rise, however. Rabobank said some now think the BoE will move even further at the next meeting in November.

"The money market has also shifted dramatically, with the odds of a 100 bps rate rise from the BoE rising dramatically this morning. It is clear that 'moderate' rate hikes from the BoE have done very little to support the pound this year against the surge in the USD. The situation has sparked speculation that the MPC may be forced into considering huge emerging market style rate hikes to prevent further sharp losses in the value of GBP," Rabobank explained.

"This, however, would pressure demand and could undo the impact of [UK Prime Minister Liz] Truss's tax cuts, leaving only the legacy of higher debt. We retain a GBP/USD1.08 target for cable."

The UK chancellor announced a "permanent" cut to stamp duty and a reversal of tax hikes as part of plans to usher in a growth-focused "new era" for the country.

During Friday's 'fiscal event', Kwasi Kwarteng abolished the top rate of income tax for the highest earners, as he spent tens of billions of pounds to drive up growth amid a cost-of-living crisis.

From April, the 629,000 people on more than GBP150,000 a year will no longer pay the top income tax rate of 45% and will instead pay the 40% applicable to those on over GBP50,271. Kwarteng also brought forward the planned cut to the basic rate of income tax to 19p in the pound a year early to April.

He also confirmed that a 1.25 percentage point national insurance hike, announced by the previous Tory government, has been cancelled. A hike in corporation tax, which would have taken the levy to 25% next year, has also been reversed. It stays at 19%.

Turning to energy bills, Kwarteng said a typical household bill be capped at GBP2,500 over the next two years. Firms will get energy bill help as part of measures funded through government borrowing, rather than through a so-called "windfall tax" on oil companies.

Analysts at ING also expect the BoE to act more aggressively at forthcoming meetings.

Tight monetary policy and a generous fiscal policy is often a recipe for success for the pound. But not this time.

ING said the market has doubts about how the UK can fund its stimulus proposals, hitting sterling as a result.

"Alongside the confirmation of additional borrowing this year, the raft of tax cuts unveiled today clearly implies that it will not be contained to just this fiscal year. The cost of the newly announced measures is reported to be GBP160 billion over five years but, with the cost of the energy price guarantee highly dependent on wholesale energy prices, investors are worried the Treasury has effectively committed to open-ended borrowing," ING said.

ING also believes that the BoE may need to act more strongly. Monetary policy is almost at loggerheads with fiscal measures, ING said.

The bank explained: "Effectively, the BoE has reserved judgement on the inflationary implications of the energy price guarantee until its November monetary policy report but noted that the net effect will likely be to boost inflation over the medium term. Given the extra tax cuts announced, markets are jumping to the conclusion that the BoE will have to respond in kind with even higher rates.

"The prospect of the BoE and the Treasury competing with each other is a particularly unnerving one for bond investors."

By Eric Cunha; [email protected]

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