- The BoE-Fed policy divergence is dragging GBPUSD lower.
- A weaker pound is a pro-inflationary factor for the UK.
The US dollar recorded its best daily performance since early March, thanks to a hawkish surprise from the Fed. Nine FOMC members indicated in their forecasts that one or more federal funds rate hikes would occur in 2026. Only one official predicted a cut, compared with 12 in March. Combined with Kevin Warsh’s determination to bring inflation back to target at all costs and the removal of the statement of intent from the accompanying document, this pushed the dollar index to a 2.5-month high.
Kevin Warsh has managed to unite the FOMC. While there were four dissenting voices at the previous meeting, there were none at the June meeting. The accompanying statement was shortened from 345 to 132 words, and the new chair avoided statements of intent. In doing so, he is putting into practice his view that the Fed should look less to the past and focus more on the markets.
The Fed’s hawkish rhetoric has raised the odds of a September rate hike from 29% to 62%. The probability of one rate hike in 2026 is estimated at 85%, and of two rate hikes at 46%. Combined with a rally in Treasury yields, this has strengthened the US dollar against major global currencies. Among other things, this has pushed GBPUSD to its sharpest decline since February.
The Fed’s readiness to tighten monetary policy complicates matters for the Bank of England. The forward market has not ruled out a 25-basis-point rate rise in 2026. However, an increasing number of investors are coming round to the view that borrowing costs will remain unchanged. The UK economy is showing signs of weakness, and inflation, according to Bloomberg estimates, will peak at 3% in 2026. This is below the BoE’s most optimistic scenario of a 3.6% price rise. The pessimistic scenario assumed that inflation would rise to 6% in early 2027.
If the Fed raises rates this year while the Bank of England keeps them on hold, the divergence in monetary policy will push down the GBPUSD exchange rate and accelerate UK inflation. In such circumstances, the best course of action for Andrew Bailey and his colleagues would be to adopt a hawkish tone. The door to a key rate hike should remain open, even if acting on it is by no means necessary.
The FxPro Analyst Team
