British Pound attempts to consolidate above 1.3400 amid US Dollar’s weakness
- GBP/USD remains steady above 1.3400, on track for a 1.4% rally in the last two weeks.
- Markets brace for a Fed pause next week and a BoE rate hike in early November.
- The US Dollar struggles with markets pondering the scope of the Fed's tightening cycle.
The British Pound (GBP) keeps heading higher against a weaker US Dollar (USD) on Thursday, as markets brace for Federal Reserve (Fed) policy next week, while in the UK the conditions are set for a Bank of England (BoE) rate hike in November. Against this background, the GBP/USD pair trades at one-month highs just above 1.3400, on track for a 1.4% rally over the last two weeks.
UK data released on Wednesday confirmed that high energy prices are boosting consumer inflation, adding pressure on the BoE to tighten borrowing costs. UK Gross Domestic Product (GDP) data, released last week, revealed that the economy keeps growing, which will make the decision easier for the central bank’s policymakers at the November 5 meeting.
Later in the day, BoE Governor Andrew Bailey is expected to speak about central bank independence at the Official Monetary and Financial Institutions Forum (OMFIF), and may provide further clues on the outlook for the next monetary policy meeting.
The US Dollar struggles as markets ponder the extent of the Fed monetary tightening cycle
The US Dollar, on the other hand, remains depressed amid lower US Treasury yields, as investors assume that the Fed is unlikely to hike interest rates at next week’s meeting and ponder the scope of the tightening cycle following dovishly tilted comments by Fed officials.
Last week, Fed Chair Warsh delivered a cautious message, refusing to pre-judge the October and December meetings while other Government Board members requested more time to assess the consequences of September's rate hike before tightening borrowing costs further.
Analysts at ING remain bullish on the Pound; “Greater market confidence in a Bank of England tightening cycle – we look for 25bp hikes in February and November – makes sterling a high-carry European currency,” says the Dutch bank in a note.
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
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