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Pound bounces back ahead of Bank of England interest rate decision

The Bank of England in the city of London. The pound was higher
The pound was trading 0.7% higher against the US greenback at $1.1541 ahead of the BoE decision on Thursday. Photo: Press Association

The pound started to bounce back against the dollar (GBPUSD=X) on Tuesday ahead of the Bank of England’s (BoE) meeting on UK interest rates later this week.

Sterling was trading 0.7% higher against the US greenback at $1.1541, while it was 0.1% up against the euro.

It came as Goldman Sachs (GS) raised its forecasts for the pound but warned that the revised levels remain lower than where spot currently is, suggesting the recent rebound has overextended.

"It should be emphasised that the UK economy remains in a difficult position, and this mostly takes policy back to where they were a few months ago when sterling was still the main adjustment mechanism for negative external shocks – ranging from energy supply to ongoing Brexit frictions," Michael Cahill, analyst at the investment bank, said.

“Taking these things together, we are revising our sterling forecasts in a more positive direction, but still expect some further GBP underperformance ahead.”

Meanwhile, Shreyas Gopal at Deutsche Bank (DB) said: “We argue that the ‘crisis’ chapter on the UK can now close, with the pound now more likely to trade as a more normal currency. Traditional positive correlations between yields and the currency can re-establish themselves.

Despite the rise on Tuesday, it still remains the worst-performing major currency so far this week.

It comes ahead of another key interest rate decision from the UK central bank on Thursday, as it looks to tame soaring inflation.

Financial markets are expecting it to continue its hawkish stance over the coming months, anticipating a 75 basis point hike on 3 November. This will bring interest rates to 3%.

The Bank is also due to start gilt sales today after building up a pile of bonds worth £838bn during its quantitative easing programme.

Read more: UK house prices fall ahead of Bank of England interest rates decision

Last month, BoE governor Andrew Bailey said: “As things stand today, my best guess is that inflationary pressures will require a stronger response than we perhaps thought in August,” pointing to a larger hike.

Analysts at Deutsche Bank have also said they expect the Bank of England to opt for a 0.75 percentage point rise with a split vote.

UK inflation rose above 10% for the second time in 2022 in the year to September amid the sharpest annual rise in food prices for more than 40 years.

The Office for National Statistics (ONS) said the consumer prices index rose to 10.1%, returning to double digits after a slight dip to 9.9% in August. City economists had forecast a slightly smaller rise to 10%.

Soaring food and drink prices were the biggest driver behind the cost of living increase.

Read more: UK mortgage approvals drop 10% as interest rates rise

Threadneedle Street has been battling runaway inflation this year in a bid to bring it back down to its 2% target. It has raised interest rates from record lows of 0.1% in the pandemic to the current 2.25% rate.

A November rise will be the eighth consecutive jump in interest rates by the UK central bank. But a 0.75 basis point hike will represent the biggest increase since 1989.

But the Monetary Policy Committee (MPC) has already faced warnings that spending cuts and tax hikes under prime minister Rishi Sunak could lead to a deeper and more enduring recession.

Watch: How does inflation affect interest rates?