When the Bank of England cut interest rates by 150bp last week, I turned aggressively bullish EUR/GBP on the belief that interest rates are headed below 2%. The currency pair has now hit a record high as the market realizes that not only will UK interest rates fall below 2%, but could be headed to Japanese levels. Against the dollar, the British pound has fallen to fresh 6 year lows but the historically significant moves are in EUR/GBP.
According to the November Inflation Report, the monetary policy committee believes that inflation will fall below their 2 percent target with the potential of hitting 1 percent. With price pressures expected to ease significantly, the Bank of England sending a strong signal that interest rates will continue to come down.
There is talk that the recessionary conditions in the UK economy could turn the UK into the next Japan. Another 200bp of easing by the end of the first quarter has been priced into the markets, which would take interest rates to 1%. If the BoE chooses to overshoot monetary stimulus, UK interest rates could be at Japanese levels.
Mervyn King has become quite a maverick and we would not be surprised to see another large rate cut from the central bank.
When the dust settles, the UK’s aggressive monetary stimulus should turn their economy around faster than the Eurozone or the US, but in the meantime, more rate cuts mean more weakness for the British pound.