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British Pound drops against its peers after BoE’s monetary policy decision

  • The British Pound edges down against its peers after the BoE’s monetary policy announcement.
  • The BoE leaves interest rates unchanged at 3.75%, with a 6-3 majority.
  • Investors doubt whether the Fed will raise interest rates to combat hot inflation.

The British Pound (GBP) drops against its major currency peers after the Bank of England’s (BoE) monetary policy decision. The GBP/USD pair edges lower from its intraday high of 1.3405 to near 1.3380; however, the initial reaction from the pair was slightly positive.

 The BoE has kept interest rates steady at 3.75%, as expected; however, the number of Monetary Policy Committee (MPC) members voting for a hold remained lower-than-expected.

Six out of nine MPC members voted for a hold against estimates of seven, while three favored an interest rate hike of 25 basis points (bps). BoE members: Catherine Mann, Chief Economist Huw Bill and Megan Greene voted for a quarter-to-a-percent hike in policy rates.

The United Kingdom (UK) central bank has warned that the energy shock would keep volatility surrounding economic growth elevated. It could also lead to second-round inflation shocks if it remains persistently high. The BoE has clarified that Stands ready to act as necessary to ensure that inflation remains on track to meet the 2% target in the medium-term

Meanwhile, the US Dollar faces intense selling pressure in the European trade, with investors turning doubtful about whether the Federal Reserve (Fed) will raise interest rates this year to fulfill its commitment of bringing inflation down.

As of writing, the US Dollar Index (DXY), which gauges the Greenback’s value against six major currencies, trades 0.15% lower to near 100.60. The USD Index has turned negative after giving back its early gains. During the day, the DXY gained 0.2% to near 101.00.

Dollar sentiment softens as FOMC signals muddled resolve on inflation

Analysts at ING describe “last night's FOMC press conference” as “a little confusing,” noting that the immediate market takeaway was that the Fed “was not going to be as tough on fighting inflation as initially thought.” In their view, investors inferred that policymakers “might try to wriggle through this period of high inflation without hiking,” reinforcing the sense of uncertainty around the Fed’s reaction function and contributing to a softer tone in Dollar and US rates pricing.

In the policy meeting on Wednesday, the Fed left interest rates unchanged in the range of 3.50%-3.75%, as expected, for the fifth time in a row.

BoE FAQs

The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).

When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.

In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.

Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.

Author

Sagar Dua

Sagar Dua

FXStreet

Sagar Dua is associated with the financial markets from his college days. Along with pursuing post-graduation in Commerce in 2014, he started his markets training with chart analysis.

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