Pound Drops Most Since Pandemic After Surprise Recession Warning

(Bloomberg) -- The pound slumped, set for its steepest slide since March 2020, as investors looked past the Bank of England's rate increase and turned their focus on forecasts for a recession in 2023.

Sterling slid as much as 2.3% to $1.2336 on Thursday, the lowest since June 2020. Yields on the two-year note fell as much as 25 basis points to about 1.39%, putting them in line with declines seen in the aftermath of the referendum on Britain's European Union membership in 2016. Ten-year gilts erased earlier gains, as Treasuries fell.

Money markets trimmed rate-hike bets, wagering 27 basis points of tightening in June. That compares with 33 basis points before the BOE lifted borrowing costs to 1%.

The moves came after the BOE raised interest rates to the highest level since the financial crisis, and warned the economy is on course to shrink next year under pressure from double-digit inflation. BOE Governor Andrew Bailey said the U.K. economy is already slowing because of a squeeze on consumer spending power.

“Don't get fooled by the hawkish dissent,” said Antoine Bouvet, senior rates strategist at ING Groep NV. “The 2023 recession, inflation at 1.5% in 2024, and rising unemployment forecast all suggest the economy won't be able to take the amount of tightening priced by the curve.”

“The issue of gilts sales is also kicked into the long grass,” Bouvet added, referring to the 1% threshold at which the BOE previously said it may consider selling gilts from its balance sheet.

The Monetary Policy Committee asked BOE staff to work on a strategy for gilt sales and intends to provide an update at its August meeting. It will start selling off its 20 billion-pound ($24.9 billion) corporate bond portfolio in September, unwinding support for the credit market in place since the aftermath of the Brexit referendum.