By Yoruk Bahceli and Amanda Cooper

Sterling Rallies on Bank of England Rate Cut

LONDON (Reuters) – Sterling rallied sharply on Thursday, solidifying its position as the best performing major currency of 2024. UK-focused stocks rose after the Bank of England cut rates but indicated future cuts may be more gradual than many had thought.

The BoE, which delivered its second rate cut since 2020, stated that after Labour Party finance minister Rachel Reeves' high-tax, high-spend budget last week, it expected higher inflation and growth.

London-listed shares of mid-sized companies touched session highs, while UK government bonds headed for their best one-day performance in almost a month, reflecting investor demand for sterling-denominated assets.

Sterling rose by as much as 0.78% to $1.298 after the decision, while two-year gilt yields fell 6 basis points to 4.448%, as bond prices rose.

The Monetary Policy Committee (MPC) voted 8-1 to cut rates to 4.75% from 5%, a stronger majority than expectations in a Reuters poll for a 7-2 vote in favor of a cut.

The BoE predicted last week's budget, which contained significant increases in tax, spending, and borrowing, would boost the size of Britain's economy by around 0.75% next year but barely improve annual growth rates in two or three years' time.

It indicated that the budget was likely to add just under half a percentage point to the rate of inflation at its peak in just over two years, causing inflation to take a year longer to return sustainably to its 2% target.

Currently, money markets show traders believe UK rates could fall by just over half a percent next year, something economists and analysts believe is too tame, given the BoE's predictions predate the rise in gilt yields and the shift in market borrowing rates following the budget.

> “Remember, markets are pricing fewer than three rate cuts from here on in,” said James Smith, developed markets economist – UK, at ING. “We don't think that sounds particularly realistic. Our view is that rate cuts will be cut at every meeting from February until rates reach 3.25% next autumn.”

British inflation has proven far more stubborn than in other developed nations, particularly regarding wages and the services sector.

Governor Andrew Bailey indicated that the BoE now sees inflation returning to target by mid-2027, from a previous estimate of mid-2026.

“That information was made less useful because it probably wouldn’t look quite like that if they took into account the market’s repricing in the wake of the budget,” remarked Rabobank senior rates strategist Lyn Graham-Taylor.

UK rates remaining higher for longer and then falling more slowly than elsewhere have been key drivers for sterling.

The pound is the best-performing major currency against the dollar this year, up 2% with Thursday's rally.

Sterling could lose that edge if markets adjust to the view that British rates could fall faster, analysts warned.

“I think that will become clear as peers, such as the U.S., begin to outpace the UK to a more significant degree, although the near-term sugar rush from the Budget might mask that for a short while,” said Pepperstone senior research strategist Michael Brown.