BoE policy outlook, the UK budget and FX and Rates implications

Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Halperni, Head of Research, Global Markets, EMEA and International Securities. It's Friday 7th November 2025 and joining Derek to post some questions on the financial market themes for the week ahead is Henry Cook, Europe Economist. The following podcast is intended for professional investors and eligible counterparties only and not for retail clients.

Any content should not be regarded as an offer to conduct investment business or an investment recommendation but for information purposes only. Hi Henry, good to have you joining the weekly podcast this week. Thanks for having me on.

Great. I guess one of the ideas of having you on was obviously in the context of this week and the Bank of England, which was one of the big events this week. Why don't we start there and just give me your take in terms of key takeaways and what it means going forward.

Yeah, I mean, it was certainly the focus, wasn't it, from a European perspective. I think a rate cut was possible after we've had some soft UK data recently, that kind of downside surprise on September, CPI in particular, but ultimately it sort of came in in line with our expectations. We saw a dovish hold from the Bank of England, the sort of inflation projections were revised down, the guidance was tweaked a little bit and there was this tighter vote split than we expected.

It was 5-4 in favour of a hold. We saw Bredin, Sarah Bredin dissent for the first time and so it was a very tight vote. The MPC is clearly very divided.

And within that, I suppose, Governor Bailey, he's the key swing voter here. Our view is that he's close to siding with the doves, but he kind of sees value in waiting until December before moving for another rate cut. But yeah, it was more or less in line with expectations.

Yes. Does that sort of align with what you saw in terms of the market reaction? Yeah.

I think the initial reaction was pound selling and rates dropped, but it wasn't really sustained. We reversed most of the move and ultimately this week the pound is roughly unchanged. We've got the yen and the euro are marginally stronger, so it hasn't been a big week in terms of the core G10 currencies.

But I think, you know, as you've implied, we've been kind of set up for a cut in December, but I just don't think there was the appetite in the markets to trade that more aggressively than what we have at the moment. And if you consider the event risk between now and that meeting in December, while we've been set up potentially for a cut, I think investors saw, you know, the two inflation reports, two job reports, the budget, there's plenty that could sway the Bank of England the other way, even though they have set us up for a cut and given it was 16, 17 basis points priced for December, there wasn't a lot of impetus to trade the view with more conviction than what's already priced. Yeah, that's right.

I think it's, you know, it's just six weeks away than the next meeting. I think between now and then, Bailey, he talked about the data and he talked about the budget. I think within that, the onus will be mostly on the data and especially the CPI numbers.

Our view is that CPI in line with the Bank of England's projections, which see headline rates falling to 3.4% in November, that would probably be enough for Bailey to vote for a cut in December. You know, we're not looking for a downside surprise here, we just think in line with the Bank of England's views would be sufficient for Bailey to move over to the dovish side in December. Yeah, yeah.

And I guess the other thing that I, certainly from a gilt market perspective, there wasn't much impetus to push yields lower, ultimately, given, you know, there was those comments in relation to the implied terminal rate priced in by the market is close to what he would consider reasonable. So maybe the markets were a little bit reluctant. Well, I guess there was no impetus for the markets to push rates lower given he was endorsing current pricing.

Yeah, yeah. Yeah. And that was part of this new communication chip by the Bank of England, we're getting much clearer comments from each individual individual MPC members on their monetary policy views.

And so, you know, it was sort of set out in black and white that he was endorsing, as you say, that kind of Taylor rule implied path, which sees rates descending slowly to 3.5% or slightly below, perhaps, our view is that the terminal rate might be 3.25%. So we see a cut in December and potentially two more next year, slightly below, I guess, what Taylor was, sorry, what Bailey is saying, but close enough. Yeah, yeah.

I guess. Yeah. It's maybe a little bit higher.

I think they were around consensus in terms of terminal rate, 3, 3.25%. So I guess what he endorsed is maybe a little bit higher than what the markets would perceive as the terminal, i.e. neutral rate that they would potentially stop, stop cutting at. I think the other thing he was sort of suggesting was that we're likely to see a slowdown in the pace of easing.

We were already seeing that, of course, by skipping yesterday, it means that that kind of established quarterly pace of rate cuts has come to an end. And comments this morning from Bailey sort of suggested that we could see an even slower pace of easing going forward as we get towards that kind of landing zone, as he sees it. Yeah, yeah.

What did you, like, obviously, somebody like you who immediately looks into the finer details of the communications, what do you think of the changes they've made? I think it's a welcome development. There's a lot more clarity there.

I think it makes it easier to get to the key bits of information straight away. Obviously, the comments from each individual MPC member are very, very helpful. But the monetary policy report as a whole, it was significantly shorter.

It was 40% shorter than it was back in August. So we've got a sort of higher quality of information and less stuff to pass through as well. So it's a welcome development, I think.

And perhaps, you know, it means we'll spend less time looking at individual MPC members' speeches in between the meetings as well. Yeah. And more efficient for us to kind of delve through the communications.

Yeah. Yeah. And I suppose from a market perspective, perhaps we'll get less noisy reactions immediately after these meetings, if it is easier to get to the meat of it.

Yeah. Yeah, definitely. And in terms of the macro view, I guess data has been coming in, well, it's been mixed, but maybe a little bit better in some areas.

Yeah. Yeah, I think that's fair to say. There was a lot of doom and gloom, I guess, earlier in the summer about the UK outlook.

But actually, the numbers are OK at the moment. Survey data has improved a little bit on the activity side. Retail sales in September were very decent.

And then we've got this story of inflation coming down, that sort of peak in September seems to have been avoided. And that disinflation process is likely to assert itself into next year, which should provide cover for the Bank of England to continue easing. So, yeah, things are looking better from a UK macro outlook in terms of the fundamentals.

Obviously, we've got the budget looming large on the horizon, it's just under three weeks away now. And so that could change things. But yeah, taking a step back, the UK outlook looks OK.

Yeah. Yeah. Yeah, I guess that's where it's kind of touching on a bit more in terms of the budget.

I think from my perspective, you know, I would say credibility is obviously going to be important. So there's two dynamics from an FX perspective. It's what's the macro hit, how big a fiscal tightening will it be, because that obviously impacts the short end of the curve in terms of Bank of England policy expectations.

But then you've also got the credibility elements, which you could argue certainly from a medium term perspective, could be something that becomes more supportive for the pound. So I guess in terms of credibility, we'll look at the other elements after. But in terms of credibility, I'm guessing the headroom will be an important figure in terms of the perception of not having to come back and do more in the future.

Yeah, I think absolutely. That's one of the first things we'll look at. I mean, in terms of credibility, ahead of the event, the chancellor has been making all of the right noises, hasn't she?

She's been talking about an ironclad commitment to the fiscal rules. She's been talking about getting inflation down and creating the sort of conditions for Bank of England rate cuts. In terms of the headroom, yeah, we'll see.

There's still this live discussion about whether she'll go for a sort of piecemeal approach with a lot of different individual measures to generate more revenue or sort of more extreme option of raising income tax, which would generate lots of revenue, but it would be politically very difficult. So there's lots of moving parts here. I think she would really like to increase the headroom above what is it now, 9.9 billion.

I would say that maybe 15 billion is the bare minimum. Markets would very much like 20 billion. Is that in line with what you think?

Yeah, yeah, exactly that. Like, I think the bare minimum is probably not going to get that much of a positive reaction in gills. And if, you know, in her speech this week, she basically implied that there would be more focus on trying to improve sustainability going forward.

So she's more or less implied that there'd be a bigger amount of headroom and therefore 15 appears the bare minimum. So I think for any kind of potential positive reaction from investors, it's got to be 20. But of course, to go for 20, obviously, depending what the OBR comes back with in terms of the fiscal hole, 20 could be a big ask, of course, and it maybe lends more into the idea that they go down the income tax like route, which, as you said, could be politically difficult.

Yeah, I guess in terms of the bigger picture, of course, this is the government's third attempt, isn't it, at resetting the fiscal narrative. We had the budget last year, we had the spring statement. So this is the third attempt.

And yeah, I suppose the hope would be that by taking this relatively market friendly approach, which is the suggestion at the moment that potentially lower borrowing costs in the future at future fiscal events could sort of provide a bit more breathing space, potentially in the scope of a reversal in the run up to the next general election. I guess that's the hope. But yeah, I mean, how do you think the FX market would react to a budget which sort of lacks credibility?

Yeah, lacks credibility and a gilt sell off, I think, would not be good. You know, the momentum is still sterling negative. In October, it was the second worst performing currency.

It's doing better so far in November, but fiscal credibility, of course, has been a big issue. So I think the concern amongst investors to have to come back and do more again would be particularly damaging. So, yeah, I think they've really got to address that.

But it's funny because at the same time, I really don't think they're going to go for tax hikes. I'm not sure what your view is, just my gut feel. I just feel the political climate at the moment is such that to go down that road, while it might make sense fiscally, is very dangerous politically with Farage on the horizon and how things could pan out for Keir Starmer in 2026.

So, you know, that's the real danger, I think. And while fiscally credibility might be good initially, the potential political instability that it brings could mean bad news for sterling down the road. Yeah, absolutely.

I mean, it's going to be a tough ask, isn't it, to communicate the need for fiscal consolidation. One of the main drivers is that OBR downward revision to its productivity assumptions, which, you know, communicating that to the public is tricky. It's very technical.

So, yeah, fraught with danger, I think, politically for this government. And political risk certainly could increase after the budget. You know, we've got local elections on the horizon.

Labour are struggling in the polls. And I think it is plausible that we could see a leadership election next year, which might be one sort of risk event on the horizon for you. Yeah, I think, you know, if that is the way in which we're going, you would imagine Keir Starmer being removed in a leadership election would ultimately result in Labour shifting somewhat left.

And that obviously would feed expectations in the markets that there's going to be looser fiscal policy, fiscal slippage, yield curve would undoubtedly steepen, there'd be renewed uncertainty in terms of gilt market performance. And I think certainly that would be not a particularly positive recipe for sterling next year. Yeah, that's right.

But as we said, taking a step back, I think the growth outlook is OK. You know, despite all of this speculation around the budget. So it is possible that if the chancellor and the prime minister can ride out this likely storm around the budget, then, you know, the pressure on them could decrease next year.

There is a narrow path there, I think. Yeah, yeah. OK, we'll look out for that on the 26th of November.

And then very quickly, then kind of looking over on the continent, any developments in Europe about the ECB last week? Yeah, I mean, that was much more straightforward than the Bank of England meeting this week. It was a pretty low key ECB meeting, to be honest.

Inflation is hovering around target. Rates are at neutral. Growth came in slightly better than expected in Q3.

So ECB policymakers are talking a lot about the good place in which they're in at the moment. It's all good for now, that's our view. But looking ahead, we do think that it could become a little bit more challenging for ECB policymakers to kind of maintain that narrative.

I think essentially our view is that the disinflation process has a bit further to run for the Eurozone. We saw this week that the ECB's wage tracker numbers came in quite low. Again, they're pointing to a sharp deceleration in pay pressures.

There's also been speculation that some regulatory changes to energy prices might be postponed. Those were due to push up prices in 2027. So all of a sudden, it's looking as though the ECB might have to confront at some point a sustained period of inflation undershooting its target.

And so we continue to expect that there might be some calibration a little bit lower on rates next year, further rate cuts to come. But yeah, I mean, despite that, I know you've got a bullish view on the Euro. Does that kind of mostly reflect US assumptions?

It does. I think, you know, we've penciled in kind of a mid-year cut from the ECB. So when you compare the periods, obviously, through the rest of this year and maybe particularly the first quarter of next year, you know, we're going to be in a period of policy stability in Europe.

Maybe some pick up in growth, certainly growth next year is expected to pick up. So we may see some feed through from fiscal policy in Germany. But yeah, like obviously, we still expect the ECB to cut by mid-year.

But in the context of the Fed being more active in cutting and indeed cutting by more than what's priced into the market at the moment, we definitely think there's scope for the Euro to rebound. So, you know, I think very short term, the dollar has been benefiting from the vacuum of information in terms of the labour market. OK, we've got all the private sector data that we can look at.

But yesterday was a good example of the Challenger job cut announcement figure resulting in this fairly notable reversal in dollar strength and some dollar depreciation coming through. And, you know, in a normal month, Challenger wouldn't get a mention. So that dearth of data is resulting in the markets looking elsewhere.

And that element of weakness in the Challenger figures yesterday did see a fairly notable reversal and we're weakening further today. So I just think, you know, Euro drifting back up into the 1.16s, let's say just scenario, we finish around 1.1650 at the end of November, within one big figure of where we are now. Then December is a very strong seasonal bias favouring dollar weakness in particular against Euro, Swiss franc.

And from 1.1650 in a December month over recent years, very feasible. You could get, you know, certainly into the 1.19s, close to 1.20 by year end. And in turn, that would support our sort of view of disinflation in the Euro area.

Exactly. Exactly. Yeah, definitely.

Definitely. You know, the government, there's a lot of risk to that and I do accept it's a stretch against it's a big move to get to 1.20. But we do genuinely think it's very feasible.

And of course, you know, the government shutdown has to end to get the data. But if it doesn't end, OK, we don't get the jobs data. But investors' concerns about the economy is going to increase day by day the longer this shutdown goes from now.

And I think that could become a negative element as well for the dollar. And then, of course, before the end of the year, we could have the confirmation of who's going to be the new Fed chair taking over from Powell next year. And that brings back potentially the whole Fed independence expectations of a more aggressive Fed in terms of cutting rates.

So I think there's plenty there that can get the dollar moving weaker and towards those levels that we have for the end of the year. Yeah, it's going to be a busy, busy few weeks ahead. Indeed.

Indeed. Great to speak, Henry. Thanks for joining us.

Thanks for having me. Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe.

Contact your MUFG sales rep for more information. Come back next week for more insights from the global markets research team.