Dollar gains momentum as markets turn to the Bank of England
Market overview
FX markets are trading with a clear policy-divergence theme after the Federal Reserve delivered a more hawkish message than markets had expected. The dollar has pushed to a two-month high, EUR/USD has broken sharply lower and sterling enters today’s Bank of England decision on the defensive. Asian G10 currencies have recovered modestly this morning alongside firmer US equity futures, while the yen has shown some resilience ahead of tomorrow’s Bank of Japan meeting. With central banks moving at different speeds and energy prices continuing to influence the inflation outlook, interest-rate expectations remain firmly in the driving seat for major currency pairs.
USD: Fed reinforces the dollar’s rate advantage
The Federal Reserve raised rates by 25bp yesterday, taking the target range to 3.75% to 4.00%, while its updated projections pointed towards further tightening this year. Growth and inflation forecasts were also revised higher, reinforcing the message that policymakers remain focused on restoring price stability.
Markets responded quickly, with short-dated US rates moving higher and the dollar gaining broadly across G10. DXY rose around 0.6% to a two-month high as investors reassessed the likelihood of another increase before year-end. The immediate USD outlook remains constructive, particularly if US data stay firm or energy prices rise further. A sustained decline in oil would reduce some of that support, but for now the combination of higher US yields and a disciplined Fed stance continues to favour the dollar.
GBP: Sterling vulnerable ahead of the Bank of England
Sterling remains under pressure ahead of today’s Bank of England decision, where Bank Rate is widely expected to remain at 3.75%. The previous MPC meeting produced a 6-3 split in favour of holding, with three members preferring a 25bp increase.
Yesterday’s UK inflation data showed CPI rising to 3.1% in August, but the detail still points to a significant contribution from energy and transport rather than a renewed acceleration across domestic price pressures. This leaves the focus firmly on Governor Andrew Bailey’s guidance and whether the Bank pushes back against the amount of tightening currently priced into the curve.
With both the Fed and ECB having raised rates in the past week, a relatively cautious BoE message would reinforce the policy gap and could leave sterling exposed against both currencies. GBP/EUR has already struggled to regain momentum this week, and a stronger pushback against future rate increases would increase the risk of further sterling weakness.
EUR: Rate support overshadowed by widening US differential
EUR/USD has broken lower following the Fed decision, with the move in front-end US rates widening the relative rate advantage in favour of the dollar. The ECB’s 25bp increase last week provides some underlying support to the euro, but the region remains particularly exposed to elevated energy costs and their impact on growth and inflation.
The balance of near-term risks therefore remains tilted towards further pressure on EUR/USD unless energy prices soften or global risk sentiment improves materially. The 1.150 area remains an important reference point, while a more sustained extension lower would bring the 1.1320 to 1.1350 region back into focus.
Looking ahead
Bank of England: Rate decision and guidance are the key event for GBP today, with markets focused on the vote split and Bailey’s assessment of future tightening.
US dollar: Further strength will depend on incoming US data, energy prices and whether markets increase expectations for another Fed hike.
EUR/USD: Rate differentials and oil remain the key drivers following the break lower.
USD/JPY: Attention shifts to tomorrow’s Bank of Japan decision, with the market looking for any signal that could challenge the current US-Japan policy gap.