Sterling firms against dollar as markets look to BoE rate guidance

Sterling edged higher against the dollar and fell versus the euro on Tuesday, as traders expect the Bank of England to maintain its rate guidance at this week's policy meeting.

The BoE is widely expected to cut its key interest rate to 4% from 4.25% on Thursday and to lower it once more before the end of the year, despite consumer price inflation rising to close to double the central bank's 2% target in June. Traders priced in over a 90% chance of an easing move this week and 86 bps of rate cuts by December 2026.

The pound was up 0.05% at $1.3290 against the dollar . The greenback rose against the euro and the yen, but remained within striking distance of Friday's lows.

"Given the stagflationary character of the data, we expect 'gradual and careful' to stay as the main forward guidance, with a highly uncertain vote split," said Citi. "We expect this situation to remain until the autumn budget, after which contractionary tax increases, in our base case, should pave the way for sequential rate cuts."

Britain borrowed more than expected in June, adding to speculation about the need for new tax hikes by finance minister Rachel Reeves later this year. "We suspect that it (the BoE) will (maintain its gradual and careful rate guidance), although any change here would almost certainly be greeted by a bout of pound weakness," said Enrique Diaz-Alvarez, chief economist at Ebury.

The British currency was last up 0.3% at 86.85 pence per euro. It fell to 87.69 pence last week, its weakest against the single currency since May 2023. Yields on UK gilts snapped a 5-day losing streak on Tuesday, with the 10-year up 2.5 bps at 4.53%.

"Risks are two-sided: a faster or more pronounced loosening of the labour market could warrant cumulative or larger cuts, whereas sticky underlying (services) inflation and only gradual signs of labour-market slack could extend the pause between cuts beyond current expectations," said Nikolay Markov economist at Pictet Asset Management.

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