Why was Sterling’s stellar run reversed?

Mr. Bailey's assertion that the Bank could become “a bit more aggressive” with its rate reductions not only cut the pound down to size; it also led the money market to fully price in a 25-bps rate cut at the next meeting in November. While we think that rates will be cut then, the outlook is not as clear cut as Bailey might seem to suggest.

We are used to central bank leaders giving ‘guidance’ like this. Fed Chair Powell does it, as does ECB President Lagarde. But we have to be careful here for we believe that some central bankers offer better guidance than others, and Bailey might be one of those that does not. To see this, we need to consider the different way in which central banks’ work. On the surface, there might not seem much difference at all.

The BoE, Fed, and ECB all have eight meetings per year, the same 2% inflation target, release minutes of their meetings and produce quarterly forecasts. But there are important differences as well, such as the way in which central bankers come to a decision to change policy.

For instance, the ECB is all about consensus building. As a result, many people doubt that any ECB central banker has ever gone into a meeting not knowing beforehand what the decision will be on rates. This is because Lagarde, and those ECB Presidents who have come before, seek to engineer a consensus when rates are about to be changed. The Bank’s chief economist Lane, and those before him, lay out to members a course of action, such as a rate cut, and members signal whether they agree or not (hint, they always seem to agree). All this means that when Lagarde gives guidance that policy is likely to change, it will almost certainly happen in the way indicated. We’d call this'strong’ guidance.

In fact, there was a bit of a furore earlier in the year when members were essentially corralled into agreeing to a future rate cut, which was signalled by Lagarde, only to find that the data released between the guidance and the date of the cut seemed to question the appropriateness of lower rates. This is, of course, a danger in any rate guidance, but it just shows the emphasis the ECB puts on the accuracy of this guidance that the bank went ahead with the cut (which was in June). In the Standard Bank’s view, the Fed delivers'strong’ guidance as well through Chair Powell, even if it may not be quite as strong as the ECB. So, here too, we can take Powell’s guidance on future policy as (almost) a cast-iron guarantee.

But what about Bailey at the BoE? The Standard Bank said there would be no consensus building on the MPC. The chief economist does not put forward a recommendation that members vote to accept or not. In short, any guidance from Bailey is, in the Standard Bank’s view, ‘weak’ guidance. And, in contrast to the ECB, it suspects that MPC members, including Bailey, are not at all sure what the outcome of a meeting will be before it takes place, and perhaps particularly at the moment.

For instance, the Bank’s Chief Economist Huw Pill voted against the majority to cut the base rate in August, something that has surely never happened at the ECB. What all this means is that we cannot trust Bailey in the same way as we can Lagarde or Powell. This is not because the BoE governor might deliberately mislead the market.

Most likely, Bailey gives his opinion and hopes, or assumes, that the majority of the MPC will follow him. But this cannot be taken as a given, and hence we are sceptical that this recent slide in the pound will develop into some sort of slump, not least because other MPC members could easily counter Bailey’s view. This being said, the irony is that we think Bailey is right; that rates should be reduced more aggressively.

What’s more, the Standard Bank thinks this will happen, as its call for the base rate at the end of this year is 4.5% against the median forecast of 4.75% in the Bloomberg poll of analysts, and 3% at the end of 2025 compared to a median of 3.75%. It trusts that subdued growth and moderating inflation will deliver these aggressive rate cuts; it is not just trusting the word of the Bank of England Governor.