Sterling dips below $1.40 on U.S. Fed hawkish surprise

Sterling fell below $1.40 and hit a 10-week high versus the euro on Thursday as markets reacted to a surprise hawkish shift by the U.S. Federal Reserve, boosting the dollar against other major currencies.

Fed officials on Wednesday signalled they would raise interest rates and end emergency bond-buying sooner than expected, pushing U.S. Treasury yields higher and equities lower.

Fed Chair Jerome Powell told a news conference “inflation could turn out to be higher and more persistent than we expect”.

The pound fell 0.7% versus the dollar in late trading on Wednesday after the move, taking it below $1.40 for the first time since early May. It was last broadly flat on Thursday at $1.39840.

Against the euro the pound was up 0.4% on the day, hitting 85.42 pence per euro – its highest level since early April.

Lee Hardman, currency economist at MUFG, said sterling’s strength versus the euro reflected bets that the Bank of England could follow the Fed’s lead and tighten policy faster than the eurozone.

“It’s a reflection of the view that the Bank of England is likely to be one of the first central banks to raise rates as well. If the Fed is willing that could give the Bank of England confidence to move earlier,” Hardman said.

Currency markets are fully pricing in one 25 basis point hike in rates by the Bank of England by December 2022. Since the start of this week, rate increase expectations have also doubled for May 2022, although the market is not yet pricing in a full hike.

Data on Wednesday showed inflation in Britain also unexpectedly jumped above the Bank of England’s 2% target in May. BoE officials have said they expect the surge to be temporary while the economy opens up after lockdowns.