Market expects UK economic growth to slow to 0.3%

The World Economic Outlook report said the UK economy would grow by 3.6% this year before slowing sharply to 0.3% in 2023, but that forecast was made ahead of the September 23 announcement of UK tax cuts. The Bank of England's emergency bond-buying program will still end on Friday, local time, a Bank of England spokesman said in an emailed statement.

British bonds extended losses after the Bank of England confirmed that its bond-buying program would still end on Friday. Ahead of the confirmation, there had been some confusion over whether the original deadline for ending bond purchases would be maintained. The Financial Times reported earlier that the Bank of England notified some banks on Tuesday that it was ready to extend the arrangement beyond the deadline.

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With the Bank of England confirming the end of bond purchases this week, the pound may continue to fall, and whether it can be supported in the future depends on the effect of the British fiscal plan. The IMF suggested that Prime Minister Truss of the United Kingdom "re-evaluate" the fiscal plan. Investors need to pay attention to the announcement of the comprehensive budget at the end of the month. If it can appease the market, the pound is expected to stabilize or even rebound.

Earlier, the pound jumped sharply against the dollar after the speech of Bank of England Governor Bailey, reversing all previous gains in the previous day and turning to decline. Bailey said that the Bank of England's bond-buying rescue measures are only temporary, and that the energy of intervention may be exhausted this weekend, and investors can only "seek more for themselves".

Britain's three-month ILO unemployment rate fell to its lowest level since 1974 in August, while wage growth accelerated. Despite all the fears of a recession, which is indeed our base case for this winter, the job market has yet to show signs of recession. However, the positive overall data masked some worrying underlying trends. Employment remains well below pre-pandemic levels.

If the Bank of England wants to act forcefully at its November meeting, these jobs data are unlikely to deter it. A rate hike of 75 or 100 basis points will depend on the success of the government's medium-term fiscal plan at the end of October to stabilize markets. If markets are calmer ahead of the November meeting, the Bank of England is more likely to raise rates by 75 basis points. But if the market turmoil continues and the pound weakens further, the Bank of England will face enormous pressure. Therefore, we tentatively expect the bank to raise interest rates by 100 basis points.

At the time when the UK announced the mini-budget that led to the most turbulent markets, the market priced the Bank of England's terminal rate as high as 6.25%, and then the market priced the terminal rate below 5.5%. It has gradually recovered to 5.8%, and is expected to exceed 6% in the next few days.

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The British government's announcement of its medium-term fiscal plan to the end of October failed to reduce market expectations for the terminal rate and the rate hike in November. At present, the probability of a 125 basis point rate hike by the Bank of England has stabilized at 75%. The Bank of England, which is concerned with financial stability, should also recognize that not aggressively raising interest rates and ensuring that inflation expectations remain stable could increase volatility in an already dysfunctional UK government bond market.

One-year implied volatility in GBP/USD has jumped to its highest level in more than a decade, now surpassing peers such as the euro, Australian dollar and even the Japanese yen. Bank of England Governor Bailey was the latest culprit in the market volatility, but then the Financial Times overturned Bailey's remarks, and the pound and the dollar regained lost ground.

After the pound rebounded more than 10% from its Sept. 26 lows, the talk of parity with the dollar cooled off a bit, but now the pressure is back. Many market participants expect the Bank of England will have to reverse its hawkish stance, which could bring some comfort to the pound. But the higher expected volatility climbs, the more likely it is that the pound will fall to new lows.