GBP/USD Rate Falls on Bets Bank of England Will Follow the ECB's Lead

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The Dollar was the ultimate winner of the European Central Bank's dovish policy announcement on Thursday, leading to losses in the Pound to Dollar exchange rate.

The ECB's decision to raise interest rates but signal a lengthy pause prompted investors to raise bets a similar outcome from the Bank of England was likely next week.

"The dovish ECB hike and another round of strong US activity data sent the dollar on another rally," says Francesco Pesole, FX Strategist at ING Bank.

The Pound to Dollar exchange rate fell 0.65% on the day to close 1.2408, mirroring the Euro-Dollar's 0.80% decline.

The ECB said interest rates have reached levels that, "maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target."

Even for a layperson, this suggests no further hikes are imminent in the near term and prompted a fall in Eurozone bond yields, and the Euro.

"We were expecting a hawkish pause, but what we got from the ECB at yesterday's Governing Council meeting was a dovish hike. After the 25bp hike in key rates, the ECB now feels that interest rates are at an appropriate level," says a note from Natixis, the investment bank.

Developments in bond and foreign exchange markets reflect the market bringing forward expectations for an ECB rate cut to earlier in 2024.

At the same time, "another Fed hike isn’t fully to be ruled out (although it is not our base case) and markets have had to reprice Fed rate cut expectations quite substantially of late on the back of resilient US economic data," says Pesole.

These developments in the relative expectations for monetary policy help explain the Euro-Dollar's losses, but what of the Pound-Dollar?

Firstly, the broader Dollar rally was always likely to hit the Pound-Dollar and other USD pairs, albeit to a lesser extent than Euro-Dollar itself.

Above: GBPUSD (top) and EURUSD at daily intervals.

But, as mentioned, the market sees a heightened risk that the Bank of England will follow the lead of the ECB and hike again next Thursday while signalling the peak has been reached.

"Sterling followed the euro lower against a backdrop of broad-based dollar strengthening yesterday, and Cable has heavily tested the 1.2400 support in the past 24 hours. The dovish tilt by the ECB likely added fuel to the ongoing dovish re-pricing of Bank of England rate expectations," says Pesole.

Already the Bank of England's Governor, Andrew Bailey, has said the Bank was approaching its final rate hike.

The Pound fell in response to Bailey's comments made before UK lawmakers in parliament, but a further downside adjustment is likely if these comments are put in print when fresh guidance is released on September 21.

The Bank has raised rates to 5.25% but given the elevated level of inflation, a further hike is likely. But data out this week revealed UK unemployment is on an upward trajectory and wage pressures will soon start to fall, easing inflationary pressures.

The Bank will sense the job is done, but for the Pound-Dollar, this could also mean further losses are in store.