The main event in the foreign exchange market on Monday was another steep peak of the sterling. The pound's approach to parity has caused a wave of speculation about an unscheduled rate hike by the Bank of England.
Yesterday, the British currency continued its loud fall, which began last week. Paired with the dollar, sterling fell by 1.6% and tested a record low of 1.0327.
Thus, since last Thursday, the pound has fallen by 5% against its American counterpart, and since the beginning of the year, the GBP/USD pair has already fallen by 21%.
The reason for the current weakening of sterling is Britain's economic gambit to reduce taxes, initiated by the country's new prime Minister Liz Truss.
Recall that on Friday, British Finance Minister Kwasi Kwarteng unveiled a mini-budget aimed at stimulating the economy by cutting taxes by 45 billion pounds.
The financial plan had the effect of an exploding bomb. Markets are concerned that the largest tax cut program since 1972 will further spur inflation in the country.
That is why the British currency did not receive any benefit from the next rate hike that occurred last week.
Like most major central banks, the BoE continues to actively fight high price growth by raising interest rates.
At its September meeting, the central bank increased the indicator by 50 bps, to the highest level since 2008 at 2.25%.
But now that inflation expectations have jumped again, this increase is clearly not enough to curb record price growth.
On the wave of pessimism, the pound set a new anti-record on Monday. However, active speculation about an unscheduled rate hike by the BoE brought it back to life a bit.
This morning, the GBP/USD pair recovered to 1.0770, which was facilitated by BoE Governor Andrew Bailey's comment from the day before.
Last night, the official said that the central bank is closely monitoring what is happening in the financial markets. If necessary, the MPC can change interest rates without hesitation.
– As much as it is necessary for a steady return of inflation to the target of 2% in the medium term, – he stressed.
In addition, the pound received support amid an incredible surge in the yield of 2-year and 5-year British government bonds. The indicator increased by 100 bps for two trading days.
This suggests that in the light of recent events, the market has revised its forecasts for the future monetary policy of the BoE.
There was an opinion that the British central bank could urgently raise rates without waiting for its next meeting, which is scheduled for November 3.
– The Bank of England will have no choice but to raise interest rates if Truss and Kwarteng do not retreat, – said economist Mohamed El-Erian. – Moreover, it will be necessary to increase the indicator by a full percentage point in order to try to stabilize the situation.
Today's speech by Huw Pill, Chief Economist of the BoE can shed light on the future plans of British politicians.
If his comment turns out to be more hawkish, it will help the GBP/USD pair to move further away from the parity line. Otherwise, the asset may tickle the nerves of pound bulls again.
– Without timely political action this week, sterling risks quickly falling below parity, – analyst Lee Hardman predicts.
Also, do not forget that the GBP/USD pair is under strong pressure from any news indicating the Federal Reserve's determination regarding interest rates.
One of the powerful triggers is expected just today. Fed Chairman Jerome Powell will deliver a speech on Tuesday.
If he again hints at a more aggressive policy of the US central bank, this will give the dollar a new growth impulse, which means that the pound will have to retreat.
But be that as it may, most analysts are inclined to believe that the British currency will remain in the zone of increased volatility this week. Now we can expect strong jumps both in one direction and in the other.