GBP/EUR declinesAs Bank forecasts end of growth for UK economyBut GBP/USD looks better supportedAnalysts warn of GBP losses

Above: Andrew Bailey, Governor of the Bank of England. Image courtesy of the Bank of England.

The Bank of England delivered what analysts are describing a "dovish" 50 basis point interest rate hike, and this could spell weakness for the British Pound going forward say analysts.

The Bank hiked interest rates by 50bp and signalled the potential for an equally large hike in September while committing to take all necessary action to tame inflation and get it back to the 2.0% target.

The 50bp hike is the largest hike since 1995 and shows a renewed determination to get on top of inflation, but it was a blitz of economic forecasts from the Bank that muddied the outlook for the UK currency.

The Bank's latest projections show the UK economy will slide into recession in late 2022 and won't return to growth for the entire length of the forecast period, i.e. into 2025.

This is a remarkably gloomy call and makes the Bank of England the first central bank to officially forecast recession.

"Large rate hikes do not guarantee currency strength, especially if the tone accompanying the move suggests a challenging economic outlook," says Daragh Maher, Head of FX Strategy for the U.S. at HSBC.

The Pound to Euro exchange rate fell three-quarters of a percent to trade at 1.1858 in the hours following the development, meaning bank accounts were quoting payment rates of about €1.1622 and payment firms were offering around €1.1820.

The Pound to Dollar exchange rate was however better supported, trading at 1.2125 close to where it started the day. Banks were seen quoting around $1.1890 for dollar payments and independent payment firms at $1.21.

Above: GBP/USD (top) and GBP/EUR (bottom) at daily intervals.

The Pound fell sharply initially but losses were largely contained with investors asking whether other central banks follow the lead of the Bank of England and predict a recession for their economies.

If the Bank of England is in fact leading the narrative and other central banks turn more downbeat, then other currencies could also experience weakness.

This is particularly the case of the Eurozone and its single currency given the area faces a similar energy crisis to that of the UK.

The Pound is nevertheless expected to depreciate further over coming weeks by some analysts who expect investors will move to price in a dour UK economic outlook through a weaker currency.

"The clear indication from the BoE’s Policy Announcement, accompanying Minutes, their Monetary Policy Report and the subsequent Press Conference is that the Bank is projecting a sharp slide into recession in 4Q’22 followed by a stagnating economy through their forecast period to 3Q’25," says Tim Riddell, Macro Strategist at Westpac.

"Even if the BoE were to keep raising rates in larger increments through the rest of this year, we doubt that it would be viewed as a favourable for the GBP as more tightening would reinforce recession risks in the UK," says Lee Hardman, Currency Analyst at MUFG.

Markets are now pricing in an additional total of nearly 100bp rate hikes this year.

"We change our Bank of England call now expecting another 50bp rate hike in September and another 25bp in November, recognising that the Bank of England is probably not ready to fully stop hiking just yet despite rising recession risks," says Mikael Olai Milhøj, Chief Analyst at Danske Bank.

Danske Bank expects EUR/GBP to move slightly higher near-term on relative rates, targeting the cross at 0.86 in 3M (GBP/EUR at 1.1628). (Set your FX rate alert here).

"Further out, GBP usually appreciates vs EUR in an environment where USD performs and expect EUR/GBP to move back towards 0.84 in 12M," says Milhøj (GBP/EUR at 1.19).

Walid Koudmani, chief market analyst at financial brokerage XTB, says the market continues to think the Bank of England moved too slowly on interest rates initially and "now they are unable to chase their tail either due to the drop in UK economic activity".

"This doesn't spell good news for the UK pound," he says.

MUFG's Hardman says a combination of elevated inflation and weak growth outlook in the UK remains negative for Sterling.

"We maintain a bearish outlook for the GBP and expect cable to drop back towards year to date lows," he tells clients in a post-BoE briefing.