Pound slides to two-month low as dollar jumps and BoE holds rates

The pound dropped to its lowest in two months, falling 0.4% to $1.321, as the Bank of England held interest rates steady and the dollar rallied on bets of US rate hikes.

The pound dropped to its lowest in two months on Thursday as bets on U.S. rate hikes boosted the dollar and the Bank of England struck a measured tone on inflation as it held borrowing costs steady, while ‌British political risks simmered in the background.

Sterling fell as much as 0.6% to $1.321, its lowest since early April, and was last down 0.4%. The pound was already trading lower as the dollar rallied but slipped further after the Bank of England held interest rates at 3.75%, judging it would be premature to hike rates given the uncertainty around ‌inflation. The BoE's approach contrasts with the European Central Bank and Bank of Japan, which both raised interest rates in recent days.

On Wednesday, traders moved to price ‌in rate increases from the Federal Reserve this year after almost half of policymakers signalled they expected a hike by December. Currency analysts said the BoE now stood out as slightly "dovish", while other central banks were taking a tougher or more "hawkish" stance on inflation.

"The currency is moving in line with relative rates," said Kit Juckes, head of FX strategy at Societe Generale. "The dollar is looking a ⁠little bit ​stronger on the back of the Fed ⁠meeting yesterday. The strength of the U.S. economy that justifies the slight shift in monetary policy stance."

Oil prices fell again on Thursday in the wake of the U.S.-Iran deal, but the focus in ⁠markets was on the potential for Fed hikes. Bets on rate increases boosted the U.S. dollar index, which tracks the currency against its major peers, to its highest in more than a ​year.

British bond yields fell after the BoE decision but remained higher on the day along with European peers, with the rate-sensitive 2-year Gilt yield ⁠last up 4 basis points at 4.183%. British stocks were 1% lower. POLITICS COULD DRIVE POUND

"We are inclined to read today’s decision as leaning a little dovish at the margin," said Nick Rees, head of ⁠macro research ​at Monex Europe. "Sterling has softened modestly post-event, but a continued path lower will depend on further signs of economic weakness, and on domestic political risks."

Polls opened on Thursday for a special election that could see Labour Manchester Mayor Andy Burnham return to Parliament and challenge embattled Prime Minister Sir Keir Starmer. Concerns among investors ⁠that Burnham might ramp up spending should he become PM contributed to a rise in British bond yields to multi-year highs in May, although the increase ⁠was largely driven by a jump in oil ⁠prices.

Yields have since fallen on the Iran peace talks and after Burnham said he would stick to the government's fiscal rules, although both gilts and the pound could be volatile on Friday should Starmer come under pressure. Politics "now looks set to ‌dictate the next leg ‌for sterling," Rees said.