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The Bank of England (BoE) cut interest rates for the second time in 2024 on November 7. The rate was reduced by 25 basis points to 4.75%. However, the central bank stated that future cuts would be gradual given that the Labour government’s first budget plan is likely to fuel inflation. In fact, the BoE expects inflation to stay above its target rate in 2025 and 2026 due to Finance Minister Rachel Reeves having increased government spending by £70 billion. The BoE also downgraded its average economic growth forecast for 2024 from 1.25% to 1%, while raising its 2025 forecast from 1% to 1.5%.
The central bank’s Monetary Policy Committee has taken a cautious stance, stating that it will ensure that interest rates remain “restrictive for sufficiently long, until the risks to inflation returning sustainably to 2.00% target have dissipated further.”
The BoE’s rate cut led to market reactions not just in the UK but globally. The FTSE 100 rose immediately after the announcement but ended the November 7 trading session down 0.3%. But the FTSE 250 ended the day up 0.8%. Meanwhile, US stock indices, including the S&P 500, hit record highs while European stocks also rose. Asian indices, such as the Nikkie 225 and Hang Seng, also climbed on the news.
The pound sterling, which has weakened following the re-election of Donald Trump as the US President, saw gains, rising 0.8% against the USD. The GBPUSD closed at 1.2985 on November 7, compared to 1.2877 on November 6. The pound found support as traders adjusted to the easing of borrowing costs in the UK and the scaled-back expectations of rate cuts in 2025.
When central banks reduce interest rates, borrowing costs decline for businesses and individuals. This encourages companies and investors to spend and invest more, which supports corporate profits and boosts share prices. Although interest rate changes usually take at least 12 months to have an observable economic impact, stock prices tend to react almost immediately, leading to initial volatility. The positive impact continues as businesses invest in equipment, expansion, new product launches and more due to lower borrowing costs. Therefore, both productivity and economic output increase.
Higher interest rates make raising capital more expensive, hurting near-term earnings and the future growth prospects of businesses. Companies might also revise their profit and growth expectations downwards. This affects the market sentiment on the stock, lowering its price. Indices are impacted when heavily weighted stocks listed on them are affected.
Investor expectations and sentiment play crucial roles in moving stock prices and indices. This is why the impact of a rate cut can be seen much before the actual announcement. When the market expects a rate cut and the economy appears healthy, stock prices soar. However, if the actual rate cut is more aggressive than anticipated or if the cut fails to materialise, it could lead to stock market volatility.
Therefore, it is important to keep an eye on market expectations and announcements by the BoE and other major central banks while making stock trading decisions. It is also important to remember that other factors also impact the stock markets, such as corporate earnings announcements, geopolitical tensions, changes in trade relations, etc.
Interest rate is one of the most important factors that influence the perceived value of a currency. This is because the interest rate dictates capital flows in and out of the country. Interest rate cuts can weaken a country’s exchange rate, which can affect forex trading in a number of ways, including:
However, interest rates are only one of the factors that move currency values and exchange rates. The other factors should also be monitored, such as inflation, trade balance, economic growth, etc.
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