GBP/USD may lose momentum ahead of Fed & BoERisk of Fed dashing market's hopes for a policy pivot BoE's decision & outlook an extra potential headwind

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The Pound to Dollar rate has regained the ground lost in September but its recovery could lose momentum this week or potentially even stall entirely due to uncertainty about the outcome and implications of forthcoming interest rate decisions from the Federal Reserve (Fed) and Bank of England (BoE).

U.S. exchange rates fell widely throughout much of last week, leading to the largest five-day decline in the Dollar Index since June just as Sterling itself benefited from financial markets seemingly welcoming the selection of former Chancellor Rishi Sunak as UK Prime Minister.

Appetite for the greenback was dampened last week by China and Japan's intervention to support the Renminbi and Yen as well as by speculation about a softening of the Fed's hawkish policy stance as soon as this Wednesday.

This and a better performance from Sterling enabled the Pound-Dollar rate to reach two-month highs above 1.16 ahead of the weekend although it could struggle to extend that recovery further in days ahead due to uncertainty about the outcome of this week's central bank decisions.

"While we think the Fed may indeed hint at a slower pace of rate hikes when it meets next week, we don’t think the FOMC will welcome the loosening of financial conditions over the past couple of weeks," says James Reilly, an assistant economist at Capital Economics.

Above: Pound to Dollar rate shown at 4-hour intervals with selected moving-averages and Fibonacci retracements of September and October rebounds indicating possible areas of technical support.

"We think the near-term risks to US interest rates remain to the upside and that by the time the FOMC’s focus shifts, the darkening outlook for global growth will drive the dollar higher as safe-haven demand increases – as has been the case in most recent global recessions," Reilly wrote in a Friday market commentary.

Wednesday's Fed decision will be poured over for signs of Fed officials softening their stance on the need to continue raising interest rates following widespread speculation suggesting that a 'pivot' to a less hawkish or simply more cautious policy stance is likely, although some analysts say this is unlikely.

The Fed has lifted its interest rates five times since March and warned with September's forecasts that the top end of the Fed Funds range is likely to reach 4.5% by year-end and 4.75% early in the new year while economists and markets expect it to raise rates to 4% this Wednesday.

"We see a risk that market participants will be disappointed if they expect a dovish ‘pivot’ from the FOMC," says Carol Kong, an economist and currency strategist at Commonwealth Bank of Australia, who sees the Pound at risk of fresh losses against the Dollar this week.

"Inflation remains stubbornly high and wages are still growing at a solid pace. The inflation backdrop is consistent with tight monetary policy settings remaining in place for some time," Kong said on Monday.

Above: Pound to dollar rate shown at daily intervals with selected moving-averages and Fibonacci retracements of August and 2022 downtrends indicating possible areas of technical resistance.

The risks this week is of the Fed raising interest rates by 0.75% for a fourth consecutive occasion, taking the Fed Funds rate to 4%, and reiterating to markets that it expects to hold borrowing costs at their eventual peak for an extended period in order to ensure inflation returns to the 2% target.

That would potentially draw a line under the Dollar's recent corrective setback and may be enough on its own to stifle the Pound-Dollar rate's rebound, although Sterling also faces risks stemming from Thursday's BoE decision, which is widely expected to result in the largest increase in Bank Rate so far.

"UK government's U-turns on tax cuts, the prospect of further fiscal policy tightening, and calmer financial markets mean the Monetary Policy Committee (MPC) faces less pressure to increase interest rates aggressively. We expect the committee to raise Bank Rate by 75bps to 3% at the November meeting," says Andrew Goodwin, chief UK economist at Oxford Economics.

"The MPC still faces a difficult balancing act in arriving at its decision. Many economic indicators have weakened since the committee last met in September, but the jobs market has remained tight and pay growth strong. The decision to replace the cap on household energy bills next April with more targeted support makes forecasting inflation harder," Goodwin wrote in a Friday research briefing

Economists and financial markets expect the BoE to lift Bank Rate by three quarters of a percentage point to 3% this week but there is a risk of the Monetary Policy Committee electing in favour of a smaller increase that would likely come as an upset for the Pound.

Above: Pound to dollar rate shown at weekly intervals with selected moving-averages.

Economists and markets have raised forecasts and expectations for Bank Rate aggressively in recent weeks after the government of former Prime Minister Liz Truss attempted to implement a large stimulatory package of tax cuts and UK inflation returned to the double-digits in September.

But since then GDP data for August has suggested the economy may be slowing faster than the BoE anticipated while the government of Prime Minister Sunak intends to cut back public spending in the year ahead, both of which undermine the case for further aggressive increases in interest rates.

To the extent that this view is adopted by the BoE this week it would imply a risk of Thursday's decision causing an upset for the market and prompting a setback for the Pound to Dollar rate over the latter half of the week.

"We expect a75bp rate hike because less expansionary fiscal policy has removed some urgency for the BoE. Nevertheless, inflation remains very high and is at risk of becoming embedded," CBA's Kong said on Monday.

"The risk is that the BoE maintains the current pace of tightening and delivers a 50bp hike. GBP can weaken more under this scenario because the BoE will have tightened by less than the FOMC," she added.