It has been a challenging week for anyone hoping the pound would keep its strength. And last night, the pressure came from an unexpected direction.
Minutes from the US Federal Reserve’s January meeting showed that some officials were not just debating when to cut interest rates – they were discussing whether to raise them. That caught markets off guard and gave the dollar a fresh lift overnight.
For the pound, this adds to what has already been a bruising few days. UK unemployment hit a five-year high of 5.2% on Tuesday. Inflation dropped to 3% on Wednesday. Both numbers point toward the Bank of England cutting rates at its March meeting, and markets now treat that as close to a done deal.
The problem for sterling is straightforward. When a central bank looks ready to cut and another is talking about doing the opposite, money tends to flow toward the higher-yielding currency. That is exactly what we are seeing.
The pound is on track for its biggest weekly fall against the euro since December. Thursday has been calmer, but the drift lower has not reversed. Gilt yields have dropped to their lowest level in over a month – a clear sign that the bond market sees a cut coming too.
The euro has its own story this week. Reports surfaced suggesting ECB President Christine Lagarde may leave before her term ends next year. The bank denied it, but the euro still dipped against the dollar on the back of the speculation.
So we have three central banks pulling in three different directions. The Bank of England looks set to cut, the ECB is holding firm, and parts of the Fed are openly weighing whether rates need to go higher. That divergence is what is driving this week’s moves.
All eyes now turn to Friday. UK retail sales and business activity data land alongside a key US inflation reading – the personal consumption expenditures (PCE) report. Those numbers will go a long way toward deciding whether this week’s trends have further to run.
