The pound has fallen to a six month low against the dollar as traders have reined in their expectations for how high interest rates will have to go in the UK.
Since mid July, when sterling was worth $1.31, the pound has steadily fallen against the dollar and was trading around $1.2260 today.
The fall reflects markets significantly readjusting their expectations for how high rates will have to go. Higher interest rates tend to attract foreign investment, boosting the value of the domestic currency.
Earlier in the summer, markets did not think it unlikely that interest rates would have to hit six per cent in order to bring down stubborn inflation.
Since then, inflation has fallen faster than expected while rate-setters at the Bank of England have indicated that they would prefer interest rates to peak at a lower level, but remain their for longer.
After holding interest rates at 5.25 per cent earlier this week, many economists now think the Bank will not hike rates any further.
New data is showing the economy is slowing fast, with some economists suggesting the UK is already in a recession. In this context, it seems unlikely that rates will climb any higher and sterling sold off at a fast pace.
Analysts at Goldman Sachs said sterling would strengthen only if policymakers “prioritise a high real rate to bring inflation swiftly down to target, ideally also supported by resilient activity.”
But this is unlikely. “The Bank has shown time and again that it is placing a higher weight on lagged policy effects, the level of rates, and a more even-handed approach with an aversion to over-tightening,” they noted.
Sterling has also come under pressure after the US Federal Reserve signalled that it might yet hike rates again this year and will almost certainly keep rates higher for longer next year.
If the US economy continues to outperform the UK, then rates in the US will likely stay high putting more pressure on sterling.
As Fawad Razaqzada, market analyst at City Index, said: “If incoming data continues to support the view that the US economy is holding its own better than the UK, then should keep the pressure on the GBP/USD for a while yet.”