U.K. Stagflation Mix, Worsening Growth Outlook Will Limit Sterling Gains, Says Mitsubishi UFG

12:29 PM EDT, 08/07/2025 (MT Newswires) -- The Bank of England cut rates by 25bps to 4.0% on Thursday, as expected, but the vote split couldn't have been narrower, said MUFG.

Higher risks around inflation expectations from food and energy prices have bolstered the hawkish camp on the BoE's Monetary Policy Committee (MPC), wrote the bank in a note to clients.

There was a clear hawkish shift in the communications from the BoE's MPC on Thursday, which, given the underlying sentiment going into the meeting was a bit of a surprise for market participants, stated MUFG. As of Wednesday, from the start of H2, sterling (GBP) was the joint worst-performing G10 currency along with the New Zealand dollar.

The data had been mixed and there was certainly enough in the data to suggest the outlook had worsened somewhat, pointed out the bank. So the 5-4 vote, highlighting more support for no change relative to May when the MPC last cut, pointed to the shift away from the focus on labor market weakness risks and onto upside inflation risks.

The foreign exchange and rates reaction has been relatively muted with the move higher in rates reflecting a reduced probability of a November rate cut, added MUFG. Wednesday, the implied probability of a November cut was close to 75% while on Thursday it's a 50-50 call.

Sterling is up a mere 0.3%-0.4%, noted the bank. The contained move reflects the fact that while the MPC was more hawkish, but for less than positive reasons. The stagflationary tilt is hardly a positive for investor sentiment.

A central bank that is curtailed from cutting rates due to sticky inflation isn't a reason to be bullish. There was also an "elephant in the room," so to speak, in the worsening fiscal outlook that could force the government into huge tax increases that will weigh on economic growth.

That is currently all speculation and as such the BoE couldn't incorporate a weaker growth profile. But that factor will add considerably to negative sentiment for sterling.

In summary, with MUFG's view of the terminal rate unchanged and with a weak growth outlook, the scope for sterling to advance on a sustained basis is low. Sterling momentum has been negative and short speculative positions have increased, so sterling may be supported by some lightening of shorts, but ultimately the bank continues to expect EUR/GBP to regain upward momentum over the coming weeks and months.

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