GBP/USD Faces Policy Split as Fed and BoE Near Key Decisions
The GBP/USD pair traded near 1.3523 on Thursday's American session, down about 0.29% from the previous day. This came after a clean reversal in direction, where the pair opened at 1.35575, hit highs of 1.35602, and then retreated to 1.35584 by the Asian cut-off.
The decline was sparked by the release of the August producer price index, which erased the pair's earlier gains. The narrow trading range for GBP/USD since Monday has been between 1.3525 and 1.3565, with sterling strengthening only 0.40% over the past month against the dollar.
The policy spread between the Federal Reserve and Bank of England is now effectively closed, with both central banks having nearly identical target ranges for interest rates. This shift in policy dynamics removes the traditional funding disadvantage that made the pound a natural short in risk-off episodes.
As a result, the pair becomes a contest of which central bank moves next and in what direction. The market is currently assigning a 62% to 64% probability to a Federal Reserve rate hike at the September 15-16 meeting, with a BoE hold on September 17 potentially leading to a dollar advantage.
However, there are also scenarios where both central banks increase rates or when the BoE hikes while the Fed holds steady. The pound's reaction to Bank Governor Bailey's testimony before the Treasury Select Committee has been consistent with expectations of no immediate rate hike, as sterling retreated from session highs and turned negative on the daily chart.
The upcoming decision on balance sheet reduction at the Bank of England's September 17 meeting may have a more significant impact on GBP/USD than the interest rate call. A faster pace of quantitative tightening could lead to higher long yields in the UK, potentially supporting sterling through the carry channel or undermining it through the fiscal-credibility channel.