Pound-to-Dollar Rate Hits New 2018 Low as Bad News Keeps on Coming for Sterling

- GBP/USD records fresh 2018 lows as bad news keeps on coming.
- Comments from Fed Chair Powell drive the US Dollar higher.
- UK inflation and Brexit news drive Pound Sterling lower.

© Goroden Kkoff, Adobe Stock

The Pound-to-Dollar rate is crashing to new 2018 lows after a combination of US Dollar strength and Sterling weakness sent the exchange rate plummeting lower.

GBP/USD fell to fresh lows Wednesday as traders reacted to comments from Jerome Powell, the head of the US Federal Reserve (Fed), who was more upbeat that expected when he testified to lawmakers in Congress on Tuesday.

The bear trend was also helped along by Sterling's weakness on the back of lower-than-expected inflation figures, which dented the odds of a Bank of England interest rate rise in August.

In testimony, Powell said; "With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that – for now – the best way forward is to keep gradually raising the federal funds rate."

The comments settled concerns over a flattening US yield curve, which led some to worry the Fed might soon stop raising interest rates. The flattening curve suggests an equally downbeat outlook for growth in the US, and that interest rates might be close to peaking.

Powell's comments, however, suggest the opposite: He stated the economy will carry on growing for several years to come, allaying fears the current growth spurt might be caused by a "sugar high" from Trump's tax reforms and fiscal stimulus. Analysts have been saying this is an 'artificial high' for the economy which, unlikely to last beyond 12 months, could be followed by a bad 'hangover'.

When asked about the threat of a trade war to the US economy, Powell answered that "tariffs will be bad for our economy and other economies," but then supplied an antidote by saying, it was "difficult to predict" the ultimate impact on US growth. Traders took the comments as a green light to buy the Dollar, which rose against nearly all its counterparts.

In the UK, meanwhile, data showed UK inflation undershot expectations in June, prompting a fall in the Pound. Headline inflation stayed at 2.4% after failing to hit the 2.6% expected by economists.

Core inflation also surprised on the downside coming out at 1.9% versus the 2.1% forecast, suggesting the slowdown was not due to temporary fluctuations in the price of fuel and food.

The below-expectations prints brought into doubt whether the Bank of England (BOE) will raise interest rates at its August meeting. Higher interest rates are a major driver for the Pound as they increase inflows of foreign capital, which is drawn by the promise of higher returns, into the UK.

"BoE rate hike expectations will be pared back for August no doubt, especially given political uncertainty. Even with a net vote in favour of a hike, we are likely to see a one and done," says Neil Jones, head of corporate and financial institutions at Mizuho Bank.

Pricing in interest rate derivatives markets currently implies an August 02 Bank Rate of 0.64%, which is just more than half way toward the 0.75% rate that would prevail if the BoE did go ahead and raise rates again next month.

This indicates a fall in the probability of a rate hike in August compared to the chances which prevailed at the beginning of April, when the implied probability was more than 80%. It suggests markets are not entirely sure the Bank will pull the trigger next month.

Brexit 'hardens' following parliamentary votes

The Pound also remains on the back-foot more broadly due to political machinations around Brexit.

"The negative impact of heightened UK political uncertainty on the performance of the pound is becoming more evident," says Derek Halpenny, European Head of Global Markets Research at MUFG .

The government only narrowly avoided defeats on key Brexit legislation in recent days, says Halpenny, which has undermined confidence in the government's ability to ensure "a smooth and orderly Brexit."

"Indeed, the government had to rely on the votes of four Eurosceptic Labour MPs to defeat the latest amendment," Halpenny adds. 

The most recent challenge to Theresa May's Chequer's Bill came from a rebel faction comprised not of "hard brexiteers" this time, but of a "soft Brexiteer" faction within the Conservative party that tabled an amendment requiring customs union membership by default should the UK fail to agree a deal with the EU before the 21 January 2019.

The amendment was narrowly defeated by 307 votes to 301 after Tory whips allegedly threatened the 'soft' faction with a general election in the event of a government failure.

The failure of the soft Brexit faction to secure the customs union amendment keeps the chances of a "hard Brexit" alive and saw Sterling weaken on Tuesday and Wednesday.

"The hard Brexit Conservatives have the numbers to sway the government's Brexit strategy, in contrast to the Rebel Remainers who have lost or withdrawn some of their key amendments. Overall, it shows that Parliament has the numbers to pass a harder - not softer - form of Brexit," says a morning strategy note from TD Securities.

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