The Bank of England is expected to lower the base rate by 25 basis points to 4.00% on August 7. Although the data is mixed, signs from the labor market and inflation suggest more cuts could happen. In June, inflation increased to 3.6%, compared to a forecast of 3.4%. At the same time, unemployment is rising, and job growth is slowing. The economy was weak in the second quarter, with GDP shrinking and poor retail sales and industrial production. The Monetary Policy Committee is divided. Members have different opinions on whether to keep the rate steady or lower it further. Some may favor a larger cut of 50 basis points because of ongoing challenges in the labor market. We expect future decreases in inflation, beginning in the fourth quarter, which could lead to more rate cuts, aiming for a base rate of 3.00% by 2026. Governor Bailey will likely avoid committing to a specific rate path due to ongoing inflation and labor market issues. The Bank of England’s forecasts for the economy and inflation are not expected to change much. It’s important to keep a close watch on incoming data to guide future decisions. With the Bank of England’s decision approaching on August 7, we are preparing for a rate cut. The best way to trade this is through interest rate derivatives, like buying Short-Term Sterling Overnight Index Average (SONIA) futures. This will allow us to profit if rates drop as expected. We consider the British pound to be at risk during this easing cycle. A lower base rate makes holding sterling less appealing, so we plan to buy put options on GBP/USD. This gives us the right to sell the pound at a fixed price, protecting us from a sudden drop while keeping our initial costs down. The split within the Monetary Policy Committee presents a chance for volatility trading. With some members possibly advocating for a bigger cut of 50 basis points, an option straddle on SONIA futures could be rewarding. This position would benefit from any significant rate movement, whether it’s a large cut or an unexpected hold. For stock markets, lower borrowing costs are usually good news for stocks. We think buying call options on the FTSE 250 index is a smart move. This index is more connected to the UK economy and should respond positively to a rate cut’s stimulus, especially after the reported 0.2% GDP contraction for the second quarter. Looking ahead, it seems that the journey toward a 3.00% rate by 2026 is set, driven by a weakening labor market. The jobless rate’s gradual rise to 4.3% earlier this year supports this outlook. We are therefore considering longer-dated derivative positions that will benefit from this trend of lower rates. However, we need to be cautious about Governor Bailey’s comments after the decision. He is unlikely to commit to a clear future path. While June’s 3.6% inflation rate is significantly lower than the over 11% highs from 2022, it still exceeds the target. This means the speed of future cuts will depend heavily on the economic data in the coming months.

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