Sterling was on track for its biggest one-day drop against the euro in over a year on Thursday, as investors pushed back their expectations for further monetary tightening after the Bank of England hiked rates for the first time in over a decade. The Bank said it expected only "very gradual" further increases would be needed after this one: two more 25-basis-point hikes over the next three years.
The pound initially spiked higher on the news of the hike, climbing to as much as $1.3279, from around $1.3215 beforehand. But it fell almost 2 US cents in the three minutes that followed, with investors focusing on the fact the BoE had not repeated previous language about markets underestimating the extent of future rises. Instead, Governor Mark Carney said the Bank was broadly on the same page as investors.
"We believe sterling weakness in response to this dovish hike is more than justified," said Alan Wilson, active fixed income portfolio manager at State Street Global Advisors. Sterling continued to slip during afternoon trading in London, hitting a 3-1/2-week low of $1.3055, 1.5 percent down on the day.
Against the euro, sterling suffered its worst one-day drop since a "flash crash" on October 7, 2016, when a sudden plunge briefly shaved off a tenth of the pound's value. It fell as much as 1.8 percent on the day versus the single currency, hitting 89.37 pence.
The BoE's trade-weighted sterling index was on course for its biggest one-day fall in almost five months, down 1.3 percent on the day. Short sterling interest rate futures soared and were last up around 9 ticks across 2018 and 2019 contracts, indicating a shallower pace of rate hikes in future.
British government bond yields fell, with five- and 10-year yields sinking around 8 to 9 basis points on the day to hit their lowest level since September 15, the day after the BoE first flagged the possibility of an imminent rate hike. For the 10-year gilt yield, the size of the drop was the biggest for any day in the last three months.
Carney said the Bank would reassess the economic outlook once it had more visibility on the nature of, and transition to, the country's new relationship with the European Union after Brexit. "Today's rate announcement needs to be viewed in the broader context - despite the modestly higher yields we anticipate, UK rates will continue to be very low by historical standards in the coming years, we believe," said BlackRock director of client solutions Vivek Paul.
"Brexit is likely to continue to loom large...and give Bank of England policymakers plenty to consider," he said. "The MPC (monetary policy committee) couldn't come out and say: 'this is a one and done hike', but the comments are hugely unsupportive towards the argument that rates need to be higher in the UK to protect against a glut of inflation in the very near future," said Jeremy Cook, chief economist at WorldFirst. "This is about the least committed hike we could have seen."
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