The pound jumped after the Bank of England kept its key interest rate unchanged and prompted traders to shunt back their predictions for negative rates.
The central bank’s Monetary Policy Committee voted unanimously to keep its policy rate at 0.1 per cent and not increase the size of its bond-buying programme. Following a survey of commercial lenders regarding the feasibility of negative interest rates, the bank said it would prepare contingency plans for such a move — but added this would take six months.
The committee was “clear that it did not wish to send any signal that it intended to set a negative bank rate at some point in the future”, said Andrew Bailey, the BoE’s governor.
Money markets suggested traders were not pricing in a move to negative rates, even two years into the future. The pound, which had started the London session around 0.6 per cent lower on fears over sub-zero rates, was 0.1 per cent higher for the day at $1.3661. Sterling also strengthened 0.6 per cent against the euro.
The UK currency rallied through the turn of the year as coronavirus vaccine rollouts and the country’s Brexit trade deal with the EU fed optimism, pushing the pound near a three-year high. But that progress has stalled in recent days, as a third Covid-19 lockdown drags on. Business activity in January was at its weakest in eight months.
Government bonds sold off following the BoE meeting, as bets that negative rates would be deployed unwound. The UK 10-year gilt yield rose 0.07 percentage points to 0.44 per cent, the highest level since late March.
“The outlook for the economy remains unusually uncertain,” the central bank said, forecasting that the UK’s gross domestic product would shrink about 4 per cent in the first quarter of this year.
The BoE, however, added that economic output would “recover rapidly towards pre-Covid levels over 2021, as the vaccination programme is assumed to lead to an easing of Covid-related restrictions”.
It made little sense for the BoE to push benchmark borrowing costs down to negative levels during national lockdowns, said Hetal Mehta, European economist at Legal & General Investment Management.
“There is no point telling people their incentive to save has now fallen when they are not even allowed to go out and spend,” she said. A reopened economy in the summer, Ms Mehta added, “would lead to very strong [consumption] growth anyway”.
The UK’s FTSE 100 share index, which is stacked with companies that earn dollar revenues, fell 0.3 per cent as sterling strengthened.
The UK benchmark has still risen about 16 per cent since the start of November as investors have bet that the “old economy” companies that dominate the index, such as oil producers and banks, will benefit from a vaccine-led global economic recovery.
“The UK index definitely ticks the boxes of benefiting from the reopening trade while it is also one of the few global markets where valuations are not too high,” said Supriya Menon, senior multi-asset strategist at Pictet Asset Management.
On Wall Street, blue-chip S&P 500 index and the tech-heavy Nasdaq Composite rose 0.7 per cent and 0.5 per cent respectively after data showed new US unemployment claims fell to their lowest since November.
This also helped prompt a sell-off in US government debt, as investors calculated that the nation’s economic recovery would eventually drive borrowing costs higher. The gap between two-year and 10-year yields widened to 1.03 percentage points on Thursday, the steepest level since 2017. Meanwhile, the difference between two-year and 30-year bond yields hit its highest level for five years, at 1.47 percentage points.
In Europe, the continent-wide Stoxx 600 benchmark was 0.6 per cent higher. Germany’s Xetra Dax rose 1 per cent after Deutsche Bank, the long-struggling German lender, reported its first annual profit since 2014.