(Bloomberg) -- The pound looks poised to extend its peer-beating performance this year after the Bank of England struck a less dovish tone than the market expected on Thursday.

While the BOE held interest rates unchanged, the central bank revised higher its expectations for inflation in the coming two years and two policymakers voted for a rate hike. The more neutral bias saw the pound trim a daily decline, and later turn positive, and strategists at Bank of America to money managers at Aviva Investors say that stance should support the UK currency going forward.

Sterling is already the best-performing Group-of-10 currency against the dollar, largely bucking a rout that’s seen the greenback push higher. Houses including Goldman Sachs see it rising further to $1.30, a level last sustained two years ago. The outperformance has been built on bets the BOE will keep rates elevated for longer than peers, a perception cemented by officials’ rhetoric. 

Goldman, PGIM See Pound Rising to $1.30 as BOE Defers Rate Cuts

“It’s arguable that a bigger shift from the hawks is needed for a cutting cycle of any kind to really begin,” said Ed Hutchings, head of rates at Aviva Investors. “For now, we would expect sterling to hold up and for gilt yields to continue some of their recent cross-market under-performance.”

While one member of the policy committee voted for a reduction, the two voting to hike rates highlighted the bank’s more cautious stance. The pound erased earlier losses to trade 0.1% higher at about $1.27 by 4:20 p.m. in London.

“The fact that there are still MPC members that are willing to consider hikes could be seen as slightly more hawkish than expected,” said Valentin Marinov, head of G-10 FX research and strategy at Credit Agricole. “The outcome of the BOE meeting could therefore give the GBP a boost.”

Slower Easing

Bets on the amount of monetary easing expected from the BOE this year were little changed after the decision, with markets fully pricing four quarter-point rate cuts to 4.25% and around a 50% chance of a fifth. The first reduction is seen in June. 

In comparison, the market expects around one-and-a-half points of cuts from the Fed, bringing the key rate to a range of 3.75% to 4%, with the first expected in May.

“The Bank of England will probably go a bit slower in easing policy than other regions,” said Jim Cielinski, global head of fixed income at Janus Henderson. “There are still policy scars from the Liz Truss and Kwasi Kwarteng era,” referring to the fallout from the previous administration’s expansive and short-lived fiscal plans.

“The Bank will want to keep an eye on sterling and make sure there isn’t an erosion of confidence, they want to be seen as prudent and the UK is probably the most tolerant of a little bit of economic pain,” he added.

Officials in the UK believe consumer-price inflation will be at the 2% target in the second quarter, thanks to tumbling energy prices. They then see it rebounding to almost 3% as the impact of cheaper energy fades and underlying price pressures in services and wages persist.

Upside Risks

Gilts initially swung to losses as the market digested the bank’s messaging, but resumed gains by the end of the BOE’s press conference, following Treasuries higher. The two-year yield slipped as much as five basis points to 4.31%, about 15 basis points below a recent peak in January. 

“We think that the outlook for the UK economy is far better than it was just a matter of months ago. That sentiment was echoed in the Bank of England’s latest economic projections, which could provide some support for UK assets,” said Matthew Landon, global market strategist at J.P. Morgan Private Bank. “We think that could provide a more attractive entry point for UK fixed income across maturities.”

The BOE also cautioned that inflation risks remain “skewed to the upside” and disruption in the Red Sea poses a potential price threat. 

“Despite a vote for an immediate rate cut, it still looks hawkish compared to what was priced in,” said Kamal Sharma, a strategist at Bank of America. “Looking at the inflation forecast — 2.3% by 2026 — they want to signal that we are not there yet on inflation and rate pricing is excessive.”

--With assistance from James Hirai, Aline Oyamada and Anchalee Worrachate.

(Updates prices throughout.)

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