Bailey says BoE will tolerate inflation overshoot due to Iran uncertainty and weak growth. That weakens sterling and supports gilts. Next MPC meeting in focus.
Bank of England Governor Andrew Bailey said on Friday that allowing inflation to run above the central bank's 2% target is justified given uncertainty about the impact of the Iran war on the economy and the weak pace of growth. That statement alters the rate path traders should anticipate.
At first glance, endorsing an inflation overshoot might sound hawkish – a central bank normally hikes to bring prices back to target. Bailey’s framing does the opposite. He is explicitly tolerating higher inflation to avoid squeezing growth further. That makes his guidance dovish relative to the BoE’s earlier posture. For forex market analysis, the immediate consequence is a lower equilibrium for sterling.
The better market read runs through real rates. If the MPC signals it will not hike even as CPI runs hot, ex-ante real yields fall. That undercuts the pound’s carry advantage and flattens the gilt curve. For GBP/USD traders, the shift removes a key support layer that had been priced in from prior tightening expectations.
Bailey’s logic ties directly to the nature of the current inflation driver. The Iran war creates a supply-side shock – higher energy and commodity costs – while simultaneously dampening demand through confidence and trade effects. The UK economy was already growing weakly before the war; adding rate hikes would destroy demand without addressing the supply bottleneck. The BoE is effectively choosing to look through the temporary spike in headline inflation, prioritising output stabilisation over strict inflation targeting.
This approach mirrors the ECB’s response to the post-2022 energy crisis. It also creates a clear policy divergence vis-à-vis the Federal Reserve, which has maintained a more aggressive tightening stance. That divergence is negative for cable.
The pound weakened on the statement. The short end of the gilt curve repriced, with markets lowering the probability of any near-term hike. If the full yield curve continues to pivot lower, GBP/USD faces sustained downside pressure. Key support levels around the recent lows will be tested if the dovish repricing extends to pricing a rate cut by year-end.
Traders should watch the May MPC meeting as the next decision point. Before that, March inflation and wage data will either confirm or challenge Bailey’s tolerance. If core inflation remains sticky and wage growth accelerates, the vote split will widen, revealing how much of this dovish tilt is shared versus contested.
The BoE’s readiness to accept above-target inflation is a structural shift in its reaction function. For currency and fixed-income positioning, that shift favours a weaker sterling and a flatter yield curve until the data forces a reassessment.
Prepared with AlphaScala research tooling and grounded in primary market data: live prices, fundamentals, SEC filings, hedge-fund holdings, and insider activity. Each story is checked against AlphaScala publishing rules before release. Educational coverage, not personalized advice.