Euro-Sterling Rises on 25bp BOE Cut Speculation, Gilt Yields Fall

Key Takeaway

• Market anticipates a 25 basis point BOE rate cut by August, diverging from the Fed's stance amid global dovish shifts.
• Euro-sterling options show bullish bets on the euro, with technicals suggesting a potential breakout against the pound.
• UK gilt yields drop 15 basis points pre-BOE meeting, reflecting high market expectations for imminent rate cuts.

BOE Meeting Sparks Speculation

As the Bank of England (BOE) meeting approaches, speculation mounts regarding the potential for a dovish policy signal. The UK's central bank has maintained a relatively hawkish stance, akin to the Federal Reserve, due to persistent wage inflation and core CPI figures running above 4% annualized. Market participants anticipate a possible 50 basis point cut by year-end, with expectations of a 25 basis point reduction as early as August. This speculation is set against a backdrop of global central banks, including the Federal Reserve, Swiss National Bank, and Riksbank, adopting more dovish positions, with rate cuts already enacted or signaled for the near future.

Economists at Bloomberg Intelligence suggest that the BOE's decision could result in a closer vote on interest rate policies, potentially hastening the timeline for a rate cut. This shift could decouple the BOE's outlook from the Fed's, impacting the pound's attractiveness as a high-yielding currency alternative. Conversely, the European Central Bank (ECB) has a rate cut anticipated for June, with the potential for reduced future rate cut bets if euro-area growth improves.

Options Market Indicates Euro Strength

The options market is already adjusting to the potential for a more dovish BOE stance, with euro-sterling risk reversals showing a preference for euro calls over puts. This sentiment, the most bullish since November, suggests a growing expectation of the euro gaining against the pound. Technical analysis supports this view, with a breakout above key levels such as the 200-day moving average and upper Bollinger band signaling a bullish trend for the euro versus the pound. However, a hawkish surprise from the BOE could challenge this outlook, potentially revisiting the 2022 low for the euro-sterling cross.

Gilts Reflect Rate Cut Expectations

The anticipation of BOE rate cuts has significantly influenced the UK gilt market, with two-year yields dropping 15 basis points in the days leading up to the meeting. This movement reflects expectations for policy easing, despite ongoing domestic price pressures. Governor Andrew Bailey's comments suggest a potential drop in inflation rates, although the absence of April's data leaves some uncertainty. The market's enthusiasm for rate cuts, as evidenced by the pricing in of a more than 90% chance for a reduction by August, may need recalibration in light of persistent high core and services inflation.

Street Views

• Economists at Bloomberg Intelligence (Neutral on the Bank of England's policy outlook):

  "The BOE decision could well see more votes for a cut, with inflation set to fall close to 2% imminently. A narrower BOE vote in favor of keeping rates unchanged would likely bring forward expectations of that rate cut prospect, breaking the link to the Fed outlook and leaning on the pound as a high-yielding currency alternative."