Sterling dropped against the dollar on Thursday after the Federal Reserve jacked up interest rates again, and as traders awaited the latest decision from the Bank of England (BoE).
The greenback rose along with U.S. bond yields after Fed Chair Jerome Powell signalled that interest rates were likely to have to rise higher than expected to crush inflation.
The dollar’s rise was particularly pronounced against the pound, with traders selling sterling in expectation the BoE would strike a less aggressive tone than the Fed.
In morning trading in London, sterling slumped 1.18% to $112.84, its lowest since Oct. 21. The euro was also stronger aganst the pound, rising 0.59% to 86.68 pence.
The Fed raised interest rates by 75 basis points (bps) for the fourth consecutive meeting on Wednesday, taking the target range to 3.75% to 4%. It stood at just 0% to 0.25% as recently as March.
Investors’ attention now turns to the BoE, which is also widely expected to raise borrowing costs by an historically large 75 bps to 3%.
“We expect the BoE to signal that a larger hike today is unlikely to be the first of a series of larger hikes and that market expectations for further hikes are likely still too aggressive,” said Lee Hardman, currency analyst at MUFG, in a note to clients. “It should encourage a weaker pound.”
Unlike the Fed, the BoE is grappling with a sharply slowing UK economy and the aftermath of the government’s disastrous mini-budget, which rocked bond markets and the pensions sector in September and October. New Prime Minister Rishi Sunak is also expected to soon announce tax rises and spending cuts that are likely to further weigh on growth.
The Fed’s Powell signalled on Wednesday the central bank may step down the rate at which it raises borrowing costs, leaving the door open for a 50 bp hike in December. But he also said the peak in rates was likely to end up higher than traders expect.
The dollar index was up 0.61% to a two-week high of 112.82.
According to futures market pricing, traders think it’s almost certain the BoE will raise rates by a lower 50 bps in December. Yet they think there’s a 51% chance the Fed opts for another 75 bps hike.
Higher rates – or the expectation of them – traditionally boost a country’s currency by making investments there look more attractive.