Pound falls as U.K. inflation at fresh 2-year low bolsters bets the Bank of England will adopt dovish tone on Thursday

By Jamie Chisholm

The pound and U.K. government bond yields fell Wednesday after a report showed inflation at its lowest in more than two years, raising hopes that the Bank of England can soon start trimming borrowing costs.

Britain's central bank is widely expected to leave its main interest rate at 5.25% on Thursday. However, news that consumer prices grew in the year to February by 3.4%, down from 4% in January, and the weakest reading since September 2021, saw traders bolster bets of a 25 basis point rate cut in June.

"A much more manageable 3.4%, cooler than had been expected, has already impacted market expectation of how many rate cuts the Bank of England might be able to push through by the end of the year," said Danni Hewson, head of financial analysis at AJ Bell.

"Money markets are once again pricing in four or even the off chance of five cuts [of 25 basis points apiece] by the end of the year, where yesterday just three seemed possible," Hewson added.

Marc Cogliatti, head of capital markets, EMEA at Validus Risk Management, noted that the headline inflation rate "was also below the Bank of England's own forecasts implying there may be a little more scope for the Monetary Policy Committee to ease than previously thought."

"This message was reinforced by a dip in the core reading which fell from 5.1% in January to 4.6% in February," Cogliatti added.

Yields on the monetary policy-sensitive 2-year gilt BX:TMBMKGB-02Y fell 5.2 basis points to 4.234%, close to a two-month low, while the pound (GBPUSD) dipped 0.2% to trade below $1.27.

The U.K. currency hit an eight-month peak near $1.29 less than two weeks ago as investors built bets that the British economy was faring better than many observers thought it would and that inflation was proving stubbornly sticky.

However, since then slower wage growth data has shown easing pressures in the jobs market, which when combined with the latest consumer prices report means the market is now poised for a dovish BOE on Thursday, according to Kathleen Brooks, analyst at XTB.

"With progress made on wage increases and inflation, there is a chance no one will vote for a hike at this meeting. This could be seen as a step closer to the BOE cutting interest rates," said Brooks.

The FTSE 100 equity index UK:UKX was down 0.2% but the more domestically focused and rate-sensitive FTSE 250 index UK:MCX rose 0.1%.

-Jamie Chisholm

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03-20-24 0844ET

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