The pound traded around its lowest in a month on Thursday, and the FTSE 100 share index fell to two-week low, both weighed down by nervousness in global markets ahead of a finely balanced Bank of England rate decision.
The BoE is expected to raise interest rates to a 15-year high of 5.25% from 5% on Thursday, although market pricing indicates a roughly 40% chance of a repeat of June’s surprise half-point increase as British inflation remains the highest of the world’s major economies.
Sterling was at $1.2688, 0.2% lower on the day, having dropped to $1.2680 the day before, its lowest since early July.
This was a turnaround from being the best performing major currency against the dollar in the first half of the year because of expectations the BoE would have to raise rates further than global peers.
Market jitters following Fitch’s downgrade of the U.S. economy that caused global share markets to fall had weighed on the pound in the last few days, Lee Hardman senior currency strategist at MUFG, said.
And over the last few weeks “the UK rate markets have moved to pare back expectations of how much the Bank of England needs to hike rates. That big move in a short period of time has taken away some of the pound’s upward momentum,” he added
Market expectations for peak Bank Rate reached 6.5% on July 11 after data showed record wage growth before falling back to 5.75% after a sharp decline in consumer price inflation.
Hardman said if the BoE were to raise rates by 25 basis points on Thursday – the decision is due at 1100 GMT – that would likely cause the pound to weaken further given that the market is pricing in a reasonable chance of 50 basis points.
In a sign of investors’ uncertainty about the outcome, overnight implied options volatility for sterling has staged its biggest two-day rise since the March banking crisis.
Implied volatility, as opposed to historical volatility – how much an asset has moved in any given timeframe – is a measure of expectations for volatility.
British share markets were caught up in the global selloff following the U.S. downgrade with the FTSE100 index down 1.46%, heading together with mainland European and U.S. shares for a third straight day of losses.
British government bonds were also under pressure. The 10-year gilt yield was up 4.5 basis points at 4.45%, in line with a similar move in the 10 year German Bund.
The two year gilt yield, was down 2 bps at 4.97%.
