The Bank of England raised its key interest rate by 25 basis points on Thursday to 0.5 percent.
This was widely expected with the UK inflation rate at 3 percent, the fastest level in five years and a full percentage point above the BOE's target rate.
But the market was focused on whether there would be further tightening in the future: The BOE's forecast for UK interest rates hinted that any more rises would be limited and gradual. And the BoE's statement mentioned the fragility of the UK economy, citing “considerable risks" due to Brexit.
Given this dovish outlook by the Bank of England, the British pound fell a full percentage after the announcement.
This was what traders call a classic “buy on rumor, sell on fact” reaction. The pound was well bid last week in anticipation of the first rate hike by the BOE in more than 10 years. But after the announcement, the currency got sold off as confirmation came that this rate hike was likely a one-off move.
The bank's nine-member Monetary Policy Committee was not unilateral in its decision: The vote to raise rates was 7-2. This reflects the dilemma that the Bank of England faces with inflation high and growth low.
In its 20-year history of independence, the Bank of England has never had to tighten rates with the UK economy so weak: It is currently growing at just 0.4 percent, which is below the average of the past five years. While the BoE kept its forecasts for growth and inflation widely unchanged from its previous meeting, future growth in the UK economy is limited to about 1.7 percent - far below the pre-crisis level of 2.9 percent.
My View: This week's move was clearly not the beginning of a string of additional tightening, but a reaction to higher inflation that was created by unusual and unprecedented factors. Now that the rate hike is out of the way, the market will focus back on Brexit negotiations, which are not going favorably for the UK. The clock is ticking, with just 18 months left in the negotiating period, and yet no detailed discussions have taken place. All of this leads to a UK economy heading down a path of continued uncertainty, which would negatively impact consumer sentiment and investment outlooks. With the U.S. Federal Reserve seemingly ready to raise rates again, it looks like the GBP has lost its luster and will start drifting lower again.
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