UK Pound gains momentum as attention shifts to interest rates

The British pound continues to show resilience as it inches closer to a two-week high against the U.S. dollar.

This positive momentum is being supported by the divergence in interest rates, with market participants anticipating that the UK will outpace both the U.S. and Europe in terms of rate increases in the coming months.

While the Federal Reserve recently paused its tightening cycle, there is widespread anticipation of a resumption of rate hikes this month. However, concerns over a slowdown in inflation have led to speculation that the Fed may adopt a more cautious approach and reassess its previous rate increases.

In contrast, the Bank of England recently raised the bank rate by half a percentage point, signalling a proactive stance in addressing inflationary pressures. Market expectations currently project a further 150 basis points of tightening by the middle of next year, underscoring the belief that inflationary pressures in the UK are persistent.

The latest consumer price inflation data for May remained stable at 8.7%, consistent with the previous month but surpassing the Bank of England’s May monetary policy report forecast by 0.3 percentage points.

At present, the pound has recorded a modest 0.1% gain against the dollar, reaching $1.2748. This marks its highest level since June 22, observed during Thursday’s trading session.

Against the euro, the pound also strengthens by 0.1%, resulting in the euro being valued at 85.35 pence.

Although the anticipation of sustained inflation has spurred market speculation of the need for aggressive tightening by the Bank of England, analysts predict that price pressures will gradually ease in the latter part of the year.

Francesco Pesole, FX Strategist at ING, points out, “Improvements in the inflation outlook later this year may lead to a reduction in market expectations of Bank of England rate hikes, potentially exerting downward pressure on the pound in the future.”

However, for the time being, it remains challenging to foresee a sustained downward trend in the pound, as it continues to benefit from prevailing interest rate differentials and positive market sentiment.