Sterling drops as BoE hikes interest rates but diverges from Fed

By Harry Robertson

LONDON (Reuters) – Sterling fell sharply on Thursday as the Bank of England (BoE) raised interest rates by 75 basis points, a day after the Federal Reserve hiked borrowing costs by the same amount.

The BoE’s rate hike was its biggest in three decades and took the main rate to 3%.

It came a day after the Fed hiked by 75 basis points (bps) and signalled rates were likely to rise more than anticipated to crush inflation, driving U.S. bond yields and the dollar sharply higher.

In contrast, the BoE’s monetary policy committee (MPC) said borrowing costs were unlikely to rise as high as markets expected before its meeting, in unusually specific guidance.

Sterling fell sharply after the BoE decision, dropping as much as 1.7% to $1.1197. It then recouped some losses and was last down 1.5% to $1.1219.

The euro rallied against the pound, rising 0.91% to 86.95 pence.

“What caught my eye is that while some central banks are saying they don’t know how high rates will go, the BoE is saying the peak is lower than what the market is pricing,” said Jan von Gerich, chief economist at Nordea. “Sterling could face some pressure against the dollar at least.”

The BoE was widely expected to raise borrowing costs by 75 bps on Thursday, although some analysts thought a 50 bps increase was a possibility.

Two BoE policymakers, Silvana Tenreyro and Swati Dhingra, voted for smaller increases of a quarter and half a percentage point respectively, reflecting concerns about the economy.

In a statement, the MPC said: “Further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.”

Markets expected the BoE to hike rates to 5.2% when the central bank finalised its forecasts.

Michael Quinn, senior trader at Monex Europe, said the negativity around sterling was driven by concerns about the economy and bets that the BoE is unlikely to match the Fed’s rate-raising zeal.

Higher rates – or the expectation of them – traditionally boost a country’s currency by making investments there look more attractive.

“The story is definitely moving from central banks pivoting to central bank policy divergence. The fundamentals in the U.S. are certainly more robust and healthy than in Europe,” he said. “It’s a pretty grim scenario for sterling at the moment.”

The Fed’s 75 bps rate hike was the fourth such increase in a row, taking the target range to 3.75% to 4%.

The dollar index was last up 0.7% to a two-week high of 112.93.

Fed Chair Jerome Powell signalled on Wednesday that the central bank may step down the rate at which it raises borrowing costs, leaving the door open for a 50 bps hike in December. But he also said the peak in rates was likely to end up higher than traders expect.

(Reporting by Harry Robertson; Editing by Mark Potter, Kim Coghill and David Evans)