GBP Vulnerable to Dovish Repricing Ahead of UK Interest Rate Decision

The British Pound (GBP) has extended its losses against the Euro (EUR), with traders trimming their exposure ahead of the Bank of England's (BoE) interest-rate decision on Thursday. Despite broadly in-line UK inflation data, the market reaction was weak.

Strategists at Brown Brothers Harriman note that the BoE is 'widely expected to keep the policy rate at 3.75% for a sixth straight meeting tomorrow given contained UK inflation pressures and ongoing labor market slack.' They highlight that market pricing remains more aggressive, with 'the swaps curve [implying] 100bps of BoE rate hikes to 4.75% over the next twelve months.'

However, BBH cautions that 'the BoE may not need to tighten as much as markets expect.' They point out that 'the UK economy is already operating below capacity,' and that 'Bank Rate at 3.75% is near the top of the BoE's estimated 2% to 4% neutral range.'

Strategists at Société Générale argue that the recent move in EUR/GBP below 0.86 has largely run its course, and that the focus now shifts to fiscal policy. They contend that 'the key event in the coming weeks is really the Budget, on October 28, rather than either tomorrow's MPC meeting, or the November 5 one, when the market currently prices in a hike.'

They caution that 'fiscal austerity in the UK could cast doubt about the UK outlook,' and see 'less urgency about further Bank of England tightening.' They warn that 'a narrowing rate differential and concerns about tighter fiscal policy suggest that if we are going to see a sterling wobble, it is likely to come this autumn.'

Société Générale also sees 'a wobble could take EUR/GBP back to 0.88 in Q4.' They note that the UK rates are already 125bp higher than in the Eurozone.