(Bloomberg) -- The pound slumped to a six-month low and gilts fell on worries the Bank of England is being too timid in its fight against inflation, setting the nation’s assets up for further losses.
The concern is that by keeping rates on hold Thursday, the BOE is underestimating a host of factors that still threaten to push consumer prices higher, focusing instead on softening the blow that tighter policy is having on the economy.
“This is bad for both sterling and gilts,” said Mark Nash, head of fixed income alternatives at Jupiter Asset Management. “They are taking risks with inflation as the pound is falling, the Federal Reserve is hawkish, wages remain strong and the labor market is still tight.”
Read more: Oil Nearing $100 Is Red Flag for Central Banks’ Inflation Fight
Traders were already turning bearish on the pound ahead of Thursday’s decision, with the market effectively split on whether the BOE would raise rates again or not. Now, with another hike no longer seen as certain, the outlook is looking increasingly bleak.
“The reaction function revealed over the last couple meetings offers little protection for sterling,” Goldman Sachs analysts including Michael Cahill wrote in a note to clients.
The pound fell as much as 0.9% to $1.2239, extending the biggest drop across Group-of-10 peers over the past month. That’s near a key technical support level that if broken, could pave the way for a slide to $1.20.
Bank of England Governor Andrew Bailey said he’s “watching the oil market very carefully” amid fears that higher prices might cause a resurgence in inflation toward the end of the year. Still, oil is just one of the factors at play. Wages in the UK are still rising at a record pace and inflation is running at more than three times the target.
“Unfortunately, some weakening in activity is unavoidable in order to put the inflation genie back in the bottle,” said Hugh Gimber, global market strategist at J.P. Morgan Asset Management. “The risk of today’s decision is that the Bank may yet be forced to apply the brakes more sharply at a later stage.”
Gilts were also dragged lower by the BOE’s announcement that it will step up the pace of quantitative tightening. The 10-year yield rose as much as 14 basis points to 4.35%, erasing its drop in the wake of Wednesday’s inflation release.
What Bloomberg Economists say...
“There will only be one more round of data before the November MPC decision and with the committee having had a chance to reflect on the latest information in its near term forecasts, we don’t think there will be enough to convince the MPC that further tightening is needed. Beyond November, the case to remain on hold will only strengthen further.”
— Dan Hanson, senior UK economist for Bloomberg Economics
Policy makers said they aim to reduce the size of the BOE balance sheet as quickly as possible to provide headroom for potential future financial stability interventions. Over the 12 months from October, it plans to reduce its gilt portfolio by £100 billion to £658 billion.
“With an increase in QT and inflation risks still to the upside, it could be longer bonds that take the brunt,” said Craig Inches, head of rates and cash at Royal London Asset Management.
--With assistance from Anchalee Worrachate and Dayana Mustak.
(Updates with Bailey’s comment in seventh paragraph.)
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