Yahoo Finance Pound jumps as markets bet on flurry of interest rate rises
Sterling rose on Thursday as investors speculated that the Bank of England will be forced to raise interest rates rapidly over the summer.
Markets seized on the Bank of England’s warning that inflation would surge to a fresh 40-year high of 11pc as evidence that officials will have to act decisively in the coming months to tame spiralling prices.
The pound climbed 0.8pc against the dollar to nearly $1.23, reversing some of the recent losses incurred when investors feared the UK’s interest rates were falling behind those in the US.
A resurgent pound, and growing fears about the state of the economy, sent the FTSE 100 down 3.1pc.
Thursday's 0.25 basis point rate hike by the Monetary Policy Committee was dwarfed by the Federal Reserve’s rate rise from 1pc to 1.75pc this week, and by the Swiss National Bank's decision to raise its interest rate for the first time in 15 years from minus 0.75pc to minus 0.25pc. The ECB has also suggested large rate hikes could be on the way in the eurozone.
But traders picked up on the Monetary Policy Committee’s warning that it will “act forcefully” if inflation shows signs of becoming a persistent problem. It may well do, with officials expecting annual price rises to surge above 11pc by the end of the year.
Investors expect the Bank to pick up the pace of rate rises in response, with increases to 1.75pc in August, 2.25pc in September and 3pc by the end of the year. That suggests a marked acceleration from the smaller rate rises of 0.25 percentage points seen in recent months.
Analyst Stefan Koopman at Rabobank said the Bank does not need to raise interest rates that steeply, but could be pushed into doing so by market expectations.
“The risk is that the market will not allow the central bank to pause. In an environment where almost all other central banks are ramping up their hiking schedules, and where countries want stronger instead of weaker currencies in order to fend off imported inflation, the value of the currency increasingly becomes a risk factor,” he said.
The fall in the pound in recent weeks had been driven in part by the gap between the Bank of England’s interest rates and those in other countries, but propping it up sustainably with higher rates is difficult.
“This places the central bank in a perilous spot: if it does too little, imported cost pressures keep flowing in, if it does too much, it will only intensify the recession,” said Mr Koopman.
Krishna Guha at Evercore ISI predicted a possible “reverse currency war” in which central banks try to support their currencies to hold down inflation, rather than the traditional move of weakening the exchange rate to try to boost their economy’s export competitiveness.
“The fact that sterling initially weakened on the decision to go only 0.25 percentage points today – and only reversed as traders then focused on the hint of one or more 0.5s ahead – will at the margin add pressure on the MPC to keep pace with its peers and the mighty US dollar in which commodity prices are set,” he said.
A rise in the currency should help control inflation by lowering import costs.
This is particularly important for commodities such as oil which are traded in dollars, meaning a weaker pound makes importing fuels more expensive. A stronger pound can mitigate some of the increases in costs.
If the pound does revert to falling, economist Ellie Henderson at Investec said “we could see further upward revisions to the inflation profile the next time the projections are released in August,” threatening to take the peak in inflation even beyond the 11pc currently predicted.
Before the Bank’s announcement economists had predicted that one or two policymakers would vote to hold interest rates. But in the event none did, indicating a growing acceptance that rates will have to rise more over time.
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