The pound remained steady as expectations for a rate hike by the Bank of England faded. After a series of central bank decisions this week, it became increasingly unlikely that the Bank of England would deliver a significant rate hike. This led to the pound hovering near two-week lows.
On Friday, the pound edged higher by 0.1% against the dollar, reaching 1.2813, and increased by 0.2% against the euro, reaching 0.8558 pence. However, against the yen, sterling fell earlier by as much as 1.1% to its lowest level in over a month.
The Bank of Japan’s announcement that it would make its yield curve control policy more flexible initially caused the yen to rally sharply. However, the rally quickly reversed, leaving the pound up 0.2% against the yen at 178.77.
The Bank of England is scheduled to meet on August 3, and although traders are leaning towards a 25 basis point rate increase, there is still a 25% chance of a half-point rise. However, the pound is struggling to make gains as expectations for aggressive rate hikes diminish.
Investors have been betting heavily on a stronger pound and currently hold their most valuable bullish bet on sterling since 2014. Nevertheless, interest-rate differentials, which have been a major driver for sterling’s increase this year, have eroded as data shows that inflation is cooling and parts of the economy are slowing. This has diminished the likelihood of a rate rise to beyond the current 0.5%.
The premium of two-year gilt yields over two-year Treasury yields has collapsed to nearly zero this month, from a multi-year high of around 45 basis points. This erosion of interest-rate differentials has weakened sterling.
In contrast to the Bank of England, the Federal Reserve has left open the possibility of more rate increases, supporting the US dollar. European Central Bank President Christine Lagarde also indicated that there may not be much more ground to cover regarding rate hikes, and any decisions on policy would depend on incoming data.
The pound is heading for a weekly gain of 1.1% against the euro, making it the largest increase this year.
Overall, the pound’s steady performance reflects waning expectations of a significant rate hike by the Bank of England. With inflation cooling and parts of the economy slowing, interest-rate differentials have eroded, weakening sterling. While investors still hold bullish bets on the pound, there are mounting concerns that the Bank of England will not be able to continue hiking rates aggressively. The outcome of the next Bank of England meeting will be closely watched by traders and investors.
