BOE Analysis: Brutally honest Bailey blasts the pound, why further falls are likely

The Bank of England has raised rates by 50 bps, the highest in 27 years, but as expected.
Forecasts of a long recession have heavily weighed on the pound.
Governor Bailey's gloomy mood, Brexit and political uncertainty are set to keep the pound depresed.

The Old Lady's last hurrah? That is what Bank of England's 50 bps rate hike looks like, one of the last such increases in interest rates, a prelude to a long recession. That is why sterling is suffering, and it has more room to fall.

While the hike to 1.75% is the biggest move since 1995, investors fully expected it. Back in June, BOE Governor Andrew Bailey signaled such a move would be high on the agenda. Markets were unaware that one member would vote for a more modest increase of only 25 bps, but there is a more significant reason for the pound to fall.

What makes this rate decision a "Super Thursday" is the BOE's quarterly Monetary Policy Report (MPR) – and it includes a "super" bombshell. The BOE forecasts a recession to being in the fourth quarter and last for five – that means throughout 2023. That is a relatively protracted downturn.

Forecasting a recession – and inflation to reach 13% – sounds stagflationary and depressing, justifying the big fall in the pound. The bank is being brutally honest, and the pound seems to prefer sweet little lies.

Will the pound continue lower? I think there is further room to the downside. First, a gloomy forecast may turn into a self-fulfilling prophecy, causing Brits to hold back on spending and employers to think twice before hiring new workers.

Second, Britain's other issues are far from being resolved. Liz Truss, the leading candidate to become UK Prime Minister, is set to enact a tough policy on Brexit, potentially causing additional trade frictions with the EU. She is seen as less fiscally responsive, something that investors dislike as well.

But even by focusing solely on BOE policy, abandoning any forward guidance is an admission of uncertainty. Markets hate uncertainty.

All in all, sterling's falls are justified, and more could be in store.

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