The Bank of England hints at economic growth risks, institutions increase short positions on the pound

According to Zhitong Finance, institutional investors are preparing for further weakness in the British pound after the latest policy decision from the Bank of England reinforced concerns about a slowdown in UK economic growth. Since the beginning of this year, Baillie Gifford has significantly reduced its bets on the pound. Institutions such as Hartford Funds and Russell Investments are also reducing their holdings in the pound, while RBC BlueBay Asset Management believes that as the market expects the Bank of England to further cut interest rates this year, there is room for further reduction in its already diminished position.

After the Bank of England announced an interest rate cut on Thursday, the pound fell by as much as 1.2%, maintaining its position as the worst-performing currency among the G10 this year. Although this decision was anticipated, the Bank of England halved its economic growth forecast for this year in an accompanying prediction, and two board members—including a former hawk—voted in favor of a significant rate cut of 50 basis points.

Shaniel Ramjee, a portfolio manager at Pictet, stated, "In the long term, given the current fiscal and economic growth conditions in the UK, it is hard to see demand for the pound. We still believe there are risks to the economy, and the Bank of England needs to further cut interest rates." He has reduced his exposure to the pound to the minimum level required for his portfolio since the beginning of the year.

The latest price adjustments highlight the urgency for Chancellor of the Exchequer Rachel Reeves to deliver on her promise to accelerate economic growth. This also refutes the notion that has buoyed the pound over the past two years: that UK interest rates would remain significantly higher than those of many other G10 countries.

Now, the likelihood of a significant interest rate cut is increasing, which is undermining the pound's long-standing status as a high-yield currency. This has also suppressed the recent rise of the pound, as hopes that the UK would not face severe trade tariffs from U.S. President Trump have diminished.

Market pricing indicates that there will be two more rate cuts this year, with a growing possibility of a third. Since early January, bets on the Bank of England's easing policy have increased significantly, when traders believed there might only be two rate cuts by 2025. More aggressively, UBS expects five rate cuts by the end of this year following Thursday's announcement.

More easing policies will translate into more currency weakness, with ING expecting the pound to fall to 1.19 against the dollar later this year, a level not seen since March 2023. BBVA expects the pound to be hit against the euro, with 1 euro potentially rising to 0.85 pounds. Nomura Holdings pointed out that considering the interest rate differentials caused by the UK's rate cuts and Japan's tightening policy, the pound could have room to drop 5% to 180 against the yen by the end of April Nomura foreign exchange strategist Dominic Bunning wrote in a report that the latest voting divergence "may continue to suppress government bond yields and increase downward pressure on the pound."

Stagflation Concerns

Even comments from Bank of England Governor Bailey regarding the voting results not being a dovish sign did little to help the pound. Some investors indicated that his stance suggests he is concerned that the country may fall into stagflation, as inflation remains high despite slowing economic growth.

Martin Harvey, a partner at Hartford World Bond Fund, stated, "At least in the short term, the economic growth outlook appears to be softening, but inflation remains high. This is a bad combination for a currency and has undermined our positive view on the pound from last year."

Since last year, the fund has been reducing its long positions in the pound. Meanwhile, BlueBay believes that if inflation triggers another surge in UK government bond yields, there is room to increase its long-held short positions in the pound.

Kit Juckes, chief foreign exchange strategist at Société Générale, said: "Ultimately, our rate cuts will be at least as large as people imagine, if not more. So why would I buy the pound at current interest rate levels?"