The risk-off sentiment in global financial markets this week has impacted Bank of England (BoE) policy expectations. The likelihood of a BoE rate cut in August has risen above 50%, pushing the 2-year gilt yield below 4%, reaching a new one-year low. Consequently, the pound is on track for its second consecutive weekly loss against the US dollar, hovering near its critical 200-week moving average around $1.2850.
Similar to the dollar, the pound's largest weekly declines have been against safe-haven currencies like the Swiss franc and Japanese yen, with the latter dropping almost 3% this week—its worst performance since the UK mini-budget crisis in late 2022. GBP/EUR is also set for a second weekly decline, retreating further from nearly two-year highs above €1.19. Given the pound's vulnerability against these major currencies, we believe markets might be underestimating the chances of UK rate cuts this year. Whether the first move happens in August or September remains uncertain, and with 1-week GBP/USD implied volatility at a one-month high, markets are bracing for a tense BoE meeting next week.
However, if the BoE issues a hawkish cut or maintains rates, emphasizing the persistent inflation risks, we could see GBP/USD and GBP/EUR rebound towards $1.30 and €1.20, respectively. This outcome, though, will also depend on broader global market conditions, as evidenced this week.
