Sterling today: Pound slips as Fed hike bets and UK inflation uptick weigh

On Wednesday, the British pound weakened as investors anticipated a likely Federal Reserve rate increase and higher UK inflation figures. GBP/USD slipped by 0.036% to 1.3474, while EUR/USD rose 0.07% to 1.1549. The dollar was supported by preparations for the Federal Reserve's decision, and a dovish rate hike may not satisfy bond investors, who now demand clear monetary policy discipline.

Francesco Pesole, an FX strategist at ING, noted that any signals of further tightening could bolster the dollar by enhancing policy credibility and reducing trade risk premium. The Federal Reserve is expected to raise interest rates by 25 basis points to 4% during the meeting, with markets projecting a 23bp increase, 52bp by year-end, and 89bp by June.

Chair Kevin Warsh's press conference is anticipated to be a pivotal factor influencing the dollar's reaction. ING suggests that the median dot plot from the Federal Reserve could indicate a median rate of 4.0% for both 2026 and 2027, which is lower than the current market expectations. August retail sales data, expected before the Fed announcement, is projected to have a minimal impact on the market due to the impending rate decision.

UK headline CPI rose to 3.1% in August from 2.9%, mainly due to a predicted 7% monthly increase in fuel costs. There is no indication from the current data that the Bank of England requires a more aggressive stance. ING expects UK headline CPI to increase to around 3.4% next month and peak near 3.7% early next year, but they anticipate the Bank of England to retain rates until 2027 unless there is a substantial rise in energy prices surpassing the 4% inflation threshold.

The euro's strength is attributed to a contrasting dollar narrative rather than a robust eurozone economy. ING forecasts that the EUR/USD rate will test 1.150 within the week, triggered by the Federal Reserve's announcement, though they do not expect a swift reversal as energy conditions persist. Should the EUR/USD rate fall below 1.150, the risks become more equitable from a technical and valuation standpoint.

ING also highlighted a potential EUR/GBP surge following the UK inflation data, expecting a rate above 0.860 in the coming days as Bank of England officials argue against further rate hikes based on their perception of subdued core inflation. ING's base case anticipates a decrease in energy prices toward the end of the year, which would reinforce both a EUR/USD floor and reduce the likelihood of a hawkish Bank of England stance.

This perspective would be threatened by a sustained increase in Brent crude prices nearing $110/bbl or an unexpected dovish statement from Warsh during Wednesday's press conference.