UK stocks rise following Bank of England rate cut

The recent decision by the Bank of England (BoE) to cut interest rates for the first time in four years has injected a fresh wave of optimism into the UK’s financial markets.

On Thursday, the central bank reduced the rate by a quarter point to 5.0%, a move that many market participants had anticipated but believed was uncertain.

This decision, coupled with a new British government following Labour's landslide election victory, has led investors to reconsider the potential of UK assets that had been largely overlooked.

Market reactions: a mixed bag

In the immediate aftermath of the BoE's decision, the FTSE 250 mid-cap share index experienced an 8% gain, matching the performance of Wall Street's S&P 500 over the past three months.

Despite this positive movement, UK stocks remain valued at a significant discount compared to U.S. indices, reflecting cautious investor sentiment.

The bond market, however, displayed a different story. The benchmark 10-year gilt yield dropped almost a full percentage point year-to-date to 3.874%, indicating a rise in the security's price and increased investor interest.

A turning point for the UK economy?

The BoE's rate cut signals a potential end to the prolonged period of weak growth and high inflation that has plagued the UK.

The country has faced significant economic challenges in recent years, including the uncertainties of Brexit, frequent leadership changes, and the repercussions of former Prime Minister Liz Truss' 2022 mini-Budget.

These factors left UK stocks undervalued and government bonds underperforming compared to their U.S. counterparts.

However, the recent developments, including the BoE's decision, suggest a shift in the economic landscape. The central bank's policymakers were narrowly divided, with a 5-4 vote in favor of the rate cut, highlighting the ongoing debate over the trajectory of inflation.

Nonetheless, the BoE raised its economic growth projections, a move that has been well-received by investors.

"The unusual combination of a rate cut and an upgraded growth forecast should be a clear positive for markets," Seema Shah, Chief Global Strategist at London-based Principal Asset Management, told Reuters.

This sentiment was echoed by Bill Papadakis, Lombard Odier's macro strategist, who told Reuters that the UK's fiscal policy now appears more stable compared to the crises of the recent past.

Global implications and currency movements

The BoE's rate cut comes amidst a broader trend of central banks around the world adjusting their monetary policies.

The European Central Bank and the Bank of Canada have also moved to reduce rates as inflationary pressures ease.

This shift contrasts with the U.S. Federal Reserve's recent decision to maintain its rate at a high level, prompting a strong U.S. dollar. Following the BoE's announcement, the British pound weakened against the dollar.

The central bank projects inflation to rise to 2.7% by the end of the year before stabilizing at the 2% target in early 2026.

Additionally, the BoE is set to discuss the future of its balance sheet tapering program next month, which could see a further reduction in government bond holdings.

(With input from Reuters)