On Wednesday, the pound saw an increase against the dollar ahead of the US Federal Reserve’s monetary policy decision but declined against the euro, following its largest daily drop against the pound in five months the day before.
Sterling rose 0.1% against the dollar to $1.2913 and fell 0.1% against the euro, trading at 85.81 pence.
The euro experienced a tumble of 0.7% against the pound on Tuesday, marking its biggest single-day decline since February. This came after data showed economic growth slowing across Europe due to stricter credit conditions.
As the European Central Bank prepared for an interest rate decision the next day, few investors were willing to push the euro much lower, anticipating a potential rate increase by the ECB and the likelihood of more to come.
“This is entirely a euro-driven movement and does not represent a bullish revaluation of the sterling’s prospects,” said Chris Turner, a strategist at ING.
Considering a slightly negative outlook for the euro due to the ECB meeting and the possibility of the US raising interest rates later in the day, Turner suggested that euro/sterling could move further downward towards the 85.20 zone in the coming sessions.
The primary driver of the currency market on Wednesday was the lead-up to the Fed’s decision on monetary policy later in the day.
Money markets indicated that traders were fully expecting a 25 basis point increase in US interest rates from the current range of 5.00-5.25%, reaching a peak around 5.45% in November.
Expectations for signals from the Bank of England during its meeting on August 3 had changed this month. Traders now anticipated an increase in UK interest rates from the current 5.0% to 5.84% by March next year, which was significantly lower than the peak of around 6.4% recorded just two weeks ago in May.
A decline in British inflation after months of double-digit figures, along with reduced business activity and cooling in the job market, eased some pressure on the BoE to continue raising interest rates.
As a result, the appeal of sterling to foreign investors diminished, as the interest rates on British bonds declined, reflecting lower rate expectations.
The two-year gilt yield, most sensitive to shifts in monetary policy expectations, dropped by 30 basis points this month to below 5%, reducing the premium compared to similar US rates to only 9 basis points, down from almost 40 basis points earlier in the month.
In this context, the British pound has declined by almost 2% in less than two weeks.
