Sterling slides on recession fears as markets temper BOE rate bets

The British pound tumbled to a 10-week low against the US dollar on Friday, falling below $1.26, as traders pared back expectations for Bank of England interest rate hikes amid growing recession risks.

Sterling slid 0.1% to $1.2591, after earlier sinking to $1.2560 for the first time since mid-June. The euro also gained 0.1% to 85.72 pence, as the pound weakened broadly.

The currency has faced selling pressure since dire business surveys for August suggested the UK economy was contracting for the first time in 18 months. Collapsing demand and tightening financial conditions point to a likely recession.

Markets are still fully pricing a 50 basis point BOE rate rise to 2.25% next month, but have slashed projected peak rates for mid-2023 to around 3.5% from over 4% previously.

“We’ve seen a marked scaling back of terminal rate expectations. Even reaching 3.75% now appears increasingly unlikely,” said CIBC’s Jeremy Stretch, who sees sterling testing multi-month lows near $1.2470.

BOE Governor Andrew Bailey is skipping the Jackson Hole summit where Fed chair Jerome Powell may provide policy clues later Friday. Deputy Governor Broadbent will represent the UK central bank instead.

“With no BOE speakers today, we’ll need to wait until Monday to see any sterling impact,” said ING’s Francesco Pesole. “Recent data volatility means the return of BOE comments can definitely move markets.”

Some improvement in consumer morale provided minor relief. The GfK index rose to -25 in August from -30, its biggest monthly jump since April, albeit still below the long-run average.

But sentiment remains fragile as households brace for more pain from soaring energy bills later this year. Real wages are already falling at the fastest pace on record.

Overall, the dismal activity data combined with still-high inflation are leaving the BOE in a bind. Further aggressive tightening risks worsening the downturn, but inaction could prolong the inflation headache.

For sterling, the growth gloom and reduced tightening expectations spell danger. The currency looks susceptible to further losses as recession fears intensify.