Forceful Fed and Weak Pound Pushing Bank of England to Act Big

With the Sterling sinking and the US Federal Reserve raising borrowing costs rather aggressively, it is understood that pressure will be high on the Bank of England (BoE) policymakers to announce a substantial interest rate hike this week.

Increase is Inevitable

Despite the fact that data showed Britain’s economy shrinking in April unexpectedly and indications that the inflationary forces may be ebbing in the labor market, the decline in the pound and the hawkish stance of other central banks have put the BoE in a tough position.

Most of the economists believe that in its Thursday meeting, the Bank of England will increase its interest rate from 1.0% to 1.25%, but many have warned that it could also turn out to be 1.50%. According to financial markets, there is an almost 43% chance that the interest rate is hiked by 50 basis points instead of 25. This is mostly because of recent events.

On Tuesday, the British pound fell below the $1.21 mark, which is the lowest it has been since May 2020. This is a major problem for the Monetary Policy Committee (MPC) because they are aware that a weaker currency will only worsen inflation in the coming months, as Britain is heavily depended on imports of energy.

Since late May, there has been a 4.5% decline in the pound against the US dollar. This was after Rishi Sunak, the Finance Minister, had announced that they would provide assistance to households dealing with a high cost of living. Many economists had believed that the package could help in boosting the confidence in the British economy as well as its currency.

Sterling Did Not Hold onto the Gains

However, Sterling was not able to retain the boost for long, as there was a higher-than-expected acceleration in US inflation, which increased bets of a hike by the Fed. Likewise, rate hikes were also flagged by the European Central Bank (ECB) last week that will happen in its next two meetings. This includes a rise of half a percentage point in September.

Monday saw the trade-weighted sterling index of the Bank of England, which measures the pound against the basket of other currencies, fall and reach the lowest it has been since January. The pound has also taken a hit because of Brexit tensions, primarily the row over the status of Northern Ireland that could impact Britain’s ties with the EU.

But, the worse has already happened for Sterling, as the US Federal Reserve has hiked up the interest rate by 75 basis points. This is the biggest increase in the rate recorded since 1994 and it is expected to boost the US dollar at the expense of the British pound.

The hawkish stance of other banks has also had an impact, which includes those of India and even Australia, which came off as a surprise for everyone. Market economists said that if the BoE continues to lag behind other global banks, this would put the British currency under even more pressure.

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