The Fed surprised with its determination to hike; will the BoE do the same?

•    The Fed raised interest rates and signalled its determination to tighten policy further.

•    The start of the Bank of England’s monetary tightening cycle will provide support for the pound.

The US dollar posted its strongest gains in the last three months against the backdrop of the Fed’s start to its monetary tightening cycle and Kevin Warsh’s hawkish rhetoric. The Federal Reserve raised rates for the first time since 2023, with the Chair stating that inflation is too high and has been above target for far too long. At the same time, the economy remains strong, and the central bank will not allow high energy prices to feed through to core inflation via second-order effects.

Investors were confident that the federal funds rate would rise from 3.75% to 4%. Their main concern was the timing and scale of subsequent rate moves. Judging by the FOMC’s updated forecasts, the Fed has only just begun to tighten monetary policy. It is prepared to take the next step before the end of the year: of the 18 Committee members, 12 expect borrowing costs to rise by a further 25 basis points in 2026, while 4 forecast a 50-basis-point increase, and only two expect rates to remain at the current level.

The futures market reacted by raising the probability of two rate rises this year to 88%, and three to 41%. In CME derivatives, the odds that the next tightening will come as early as the end of October have risen to nearly 58%. This has bolstered the US dollar, as has the end of the sell-off in long-term Treasuries against a backdrop of market confidence in the Fed’s determination to combat inflation. Confidence in the central bank is returning, and with it, confidence in US assets.

How will the others respond? Hawkish rhetoric opens the door to monetary tightening by other regulators who had previously been hesitant. And the Bank of England may be the first to spring a surprise. It is expected to keep its repo rate at 3.75% at its September 17th meeting, with a 6-3 vote. The futures market puts the probability of a rate rise at 34%. However, the acceleration in consumer prices from 0.3% m/m to 0.5% and in core inflation from 0.2% to 0.3% in August, coupled with the start of the Fed’s monetary tightening cycle, could feed the hawks in the MPC.

The base-case scenario is that borrowing costs will remain unchanged and that Andrew Bailey will adopt a hawkish tone at the press conference. Moreover, the futures market expects five rounds of monetary tightening over the next 12 months, two more than the Fed. If the Bank of England begins tightening as early as September, this will provide support for the pound.

The FxPro Analyst Team