The pound falls over 1% against the dollar and euro following remarks from the Bank of England governor about interest rates.

• On Thursday, the British pound dropped over 1% in value against the U.S. dollar, following Bank of England Governor Andrew Bailey's statement to the Guardian that more positive news regarding inflation could enable the central bank to adopt a more assertive stance in its interest rate reduction strategy.
• In September, the BOE maintained interest rates at 5% despite reducing them by 25 basis points in August, due to worries about rising service inflation.
• Bailey informed the Guardian that he was optimistic about the cost of living pressures not being as persistent as initially assumed.

On Thursday, the British pound dropped over 1% in value against both the U.S. dollar and euro, following Bank of England Governor Andrew Bailey's statement that more positive inflation data may prompt the central bank to adopt a more aggressive stance on interest rate reductions.

At 4:45 p.m. in London, sterling was down 1.16% to $1.3113, slightly recovering from losses of over 1.3% but still close to its lowest intraday level since September 12. This decline put sterling on track for its steepest daily drop against the dollar in over 20 months, according to a CNBC calculation of LSEG data.

In an interview with the Guardian newspaper on Thursday, Bailey stated that the BOE may adopt a more "activist" approach to rate cuts if inflation trends persist.

According to the Guardian, he stated that he was optimistic about the cost of living pressures not being as persistent as initially assumed.

The pound strengthened after the Bank of England's monetary policy meeting on September 19, as British policymakers adopted a more hawkish stance than their counterparts at the US Federal Reserve and European Central Bank. Additionally, the pound received support during the summer from the Labour party's decisive victory in the early July general election, with investors looking forward to a period of political stability and the possibility of pro-business reforms.

The upcoming budget, set to be revealed in October, has sparked doubts about the sustainability of optimism surrounding U.K. assets. Political leaders have repeatedly hinted that tax increases and fiscal restraint will be necessary to address a budget deficit.

On Thursday, the pound dropped 1.1% against the euro, reaching its lowest level since September 2020. This decline put sterling on track for its steepest daily decline against the greenback in over 20 months, according to a CNBC calculation of LSEG data.

Despite several analysts raising their expectations for the pace of European Central Bank rate cuts this year, after both euro zone and German inflation prints came in below 2% this week.

The ECB is expected to cut its interest rates by 25 basis points at its October meeting, followed by another reduction at its December meeting, according to Bank of America Global Research and Moody's Analytics. BOA Global Research now forecasts the ECB's deposit rate to be at 2% by June 2025, a quarter earlier than its previous prediction.

Despite headline inflation remaining near its 2% target, the Bank of England's Monetary Policy Committee expressed concerns about services inflation and wage growth during its September meeting, and kept the key rate unchanged at 5%.

The BOE's money market pricing on Thursday indicated a high likelihood of two more 25-basis-point cuts this year during its remaining meetings.

According to Shreyas Gopal, FX strategist at Deutsche Bank, the MPC may not cut rates back-to-back in November and December if inflation takes an unexpected turn. Previously, the guidance suggested that inflation needed to surprise to the downside for a shift away from the "gradual" pace of easing.

ING's FX strategist, Francesco Pesole, stated that the "pound correction" may reach 1.3 in the near future due to a "probably long-due dovish repricing" and higher U.S. dollar swap rates.

Inflation risks

Jane Foley, a senior FX strategist at Rabobank London, stated in a Thursday note that Bailey's recent comments on the potential for more aggressive rate cuts had "deeply shaken" support for sterling. However, she noted that the interview also featured the governor discussing potential risks to the inflationary outlook from a spike in crude oil prices, following the latest flare in Middle East tensions.

Bailey stated to the Guardian that geopolitical concerns are extremely pressing, and there are evident stresses. The real issue lies in how these tensions may affect already strained markets in certain regions.

Bailey stated that the central bank had not been affected by major oil price increases, but it was closely monitoring the situation for any potential effects.

"From my discussions with regional counterparts, I sense a strong commitment to maintain market stability at the moment," he stated.

Foley of Rabobank stated on Thursday that although the market focused on the rate cut aspect of Bailey's statement, inflation risks would remain crucial. Despite the potential impact of a Middle Eastern escalation being disregarded, U.K. inflation risks still indicate that the BoE may be slower to cut rates than many of its counterparts.

— CNBC's Ganesh Rao contributed to this story.