Sterling gains against a weaker dollar amid Fed credibility worries

By Linda Pasquini

(Reuters) -Sterling rose to its highest in nearly four years against the dollar on Thursday, as worries around the credibility of the U.S. Federal Reserve dragged the greenback lower on its fourth consecutive day of losses.

The pound was up 0.56% against the dollar at $1.374, after earlier in the session surpassing January 2022 highs to trade at levels not seen since October 2021.

"(Sterling) price action is baffling," said Nick Rees, head of macro research at Monex Europe, as it "completely ignores the difficulties facing the UK government".

Rees pointed to a brewing rebellion among lawmakers of Prime Minister Keir Starmer's Labour party which he said "is going to torpedo" proposed reforms to the welfare system.

Due to ballooning welfare spending, which was on course to top 100 billion pounds by 2030, Labour said in March it planned to cut more than 5 billion pounds from its welfare budget by 2029/30 as it sought to avoid a rise in taxes or borrowing, "neither of which are outcomes that markets are going to like," Rees said.

He pointed to late 2022, when British markets were racked by then-Prime Minister Liz Truss's failed "mini-budget", and another drop in sterling and rise in gilts, albeit to a lesser extent, when British finance minister Rachel Reeves announced a tax-and-spend budget in October that investors worried would reignite inflation and weigh on growth.

While the euro is set to gain more than 1% over the pound this month, sterling regained some ground in recent days. It was broadly steady against the euro, which was down 0.1% at 85.27 pence.

This week, a survey showed Britain's labour market was showing further signs of slowdown, which pointed to below-inflation pay growth and a drop in job vacancies, especially for graduate-level jobs.

Bank of England Governor Andrew Bailey on Tuesday said there were now signs that Britain's labour market was softening and he repeated his view that interest rates were likely to continue falling.

Markets see a 64% chance of a rate cut from the BoE in August.

Sterling gained more than 2% against the dollar so far this week.

"I think once things calm down and markets have a little bit more time to focus on the UK fiscal situation, I think big, big downside risk is building for the pound that could start to play out," Rees said.

(Reporting by Linda Pasquini; Editing by Alex Richardson)