Markets bet Bank of England will be forced to act in ‘reverse currency war’

The pound’s fall in recent weeks was partly due to the mismatch between the Bank of England’s interest rates and those of other countries, but it’s difficult to sustainably prop it up with higher rates.

“This puts the central bank in a dangerous position: if it does too little, imported cost pressures will continue to flow in; if it does too much, it will only deepen the recession,” Koopman said.

Evercore ISI’s Krishna Guha predicted a possible “reverse currency war” in which central banks seek to support their currencies to keep inflation low, rather than the traditional move of weakening the exchange rate to try to boost export competitiveness to increase their economy.

“The fact that sterling initially weakened on the decision to go just 0.25 percentage point today – and only reversed when traders then focused on the hint of a 0.5 second lead or more – will increase pressure on the MPC to keep up with competitors and the powerful US dollar, in which commodity prices are set,” he said.

A rise in the currency should help control inflation by lowering import costs.

This is particularly important for commodities like oil, which are traded in dollars, meaning a weaker pound makes it more expensive to import fuel. A stronger pound may mitigate some of the cost increases.

Should the pound fall again, Investec economist Ellie Henderson said “we could see further upward revisions to the inflation profile when the forecasts are next released in August,” and threatened to peak inflation even beyond the currently forecast 11 percent reach.

Before the bank’s announcement, economists had predicted that one or two policymakers would vote to keep interest rates on hold. But if that wasn’t the case, it suggests a growing acceptance that rates must continue to rise over time. Markets bet Bank of England will be forced to act in ‘reverse currency war’

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