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Senior Market Analyst
The Federal Reserve and the Bank of England are both raising interest rates, yet currency markets are treating their paths very differently. Fed vs. BoE rates now diverge on conviction, with a Federal Reserve hike fully priced for its next meeting while the Bank of England carries only a 75% probability of another 25-basis point increase. That gap has lifted the U.S. dollar to a 19-month high against its major peers and pushed sterling lower, even with UK growth running at its strongest pace in two and a half years.
Fiona Cincotta, StoneX Senior Market Analyst, covers currencies, equities and commodities, with a focus on UK and European macro themes. That coverage gives insight into how Federal Reserve and Bank of England rate expectations are driving sterling and the U.S. dollar.
The U.S. dollar trades at a 19-month high against its major peers, driven by a hotter-than-expected U.S. inflation report and hawkish commentary from Federal Reserve officials. According to Cincotta, Governor Christopher Waller went further by raising the idea of "an outsized 50 basis point rate hike" at the next meeting. A standard Federal Reserve hike at that meeting is now fully priced, and expectations of further increases beyond it are adding support to the greenback. As a result, Treasury yields have climbed and the U.S. dollar has pushed higher against its major peers. "The market's only pricing that in as a 10% probability, but that didn't exist before," she adds of the larger move.
The Bank of England raised interest rates by 25 basis points at its latest meeting, and markets price a 75% chance of another 25 basis point hike at the next one. Brent crude has fallen sharply, which raises questions about how much further the Bank of England needs to go. As Cincotta puts it, "That's a huge decline in Brent. But the Bank of England still does expect inflation to rise to almost 5%." Consequently, sterling rests on a rate path that markets price with less conviction than the Federal Reserve's, leaving the pound exposed to U.S. dollar strength even with UK growth at its strongest in two and a half years.
The rate gap between the Federal Reserve and the Bank of England shows up first in U.S. inflation data, Federal Reserve commentary and energy prices. U.S. inflation reports, including producer price data, show if price pressure is keeping Federal Reserve hike expectations firm, while speeches from Federal Reserve officials reveal how seriously policymakers weigh larger moves. Brent crude prices and UK GDP releases show how much inflationary pressure the Bank of England faces. Market-implied hike probabilities show how firmly each central bank's next move is priced.
--- Written by Mohamed Faisal, Global Macro Content Specialist
--- Expert: Fiona Cincotta, StoneX Senior Market Analyst
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Federal Reserve hike bets are running ahead of the Bank of England, and the U.S. dollar is reaping the reward. Hotter U.S. inflation and a sliding Brent price are pulling the two central banks' rate paths apart, leaving sterling on the back foot.
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