The pound is under mounting pressure amid fears the Bank of England will be outpaced by the US in the fight against inflation.
Sterling slumped as low as $1.2162 yesterday, taking its losses against the dollar to nearly 10 per cent this year.
It came after official figures showed inflation in the UK hit 9.1 per cent in May, which is another 40-year high.
Falling pound: Sterling slumped as low as $1.2162 yesterday – taking losses against the dollar to nearly 10% this year
But analysts said the rise in the cost of living was unlikely to be enough to persuade the Bank to implement more aggressive interest rate hikes despite mounting criticism of its handling of the crisis.
The central bank has raised rates five times since December but never by more than 0.25 percentage points. The rate now stands at 1.25 per cent.
By contrast, the US Federal Reserve bumped up rates by 0.75 percentage points last week, the biggest rise since 1994, after a 0.5-percentage-point hike in May.
And it is expected to raise rates by another 0.75 percentage points in July and by 0.5 percentage points in September.
Analysts warned that the drastically different approach to tackling inflation in London and Washington was likely to weigh further on the pound.
Rising interest rates – used by central banks to tame inflation – typically boost a currency as investors hunt better returns.
The dollar tends to fare well in times of trouble as the currency is seen as a safe asset by international investors.
James Reilly, assistant economist at Capital Economics, said: ‘We expect the pound to weaken further against the US dollar over the rest of 2022 as the Bank of England fails to keep pace with the Fed and appetite for risk continues to weaken.’
Andrew Sentance, a former member of the Bank’s rate-setting monetary policy committee, said: ‘The financial markets have given their verdict on UK inflation and the lack of response.
‘The pound is falling. UK economic policy is in disarray.’ The cost of living crisis has already weighed on the pound, with traders fearing Britain will topple into recession as households and businesses tighten their belts.
The slump has hit holidaymakers who get less bang for their buck overseas, and importers find it more expensive to buy foreign goods.
Federal Reserve chairman Jay Powell last night paved the way for more rate rises, telling the Senate banking committee: ‘The American economy is very strong and well positioned to handle tighter monetary policy.’
In theory, higher rates should keep inflation down by encouraging saving rather than spending.
But this can also throw economic growth into reverse, a prospect which has caused the Bank of England to pull back from big hikes.
Powell conceded that a recession in the US was ‘certainly a possibility’ but added that the likelihood was ‘not elevated’.
With traders unsure what to make of Powell’s comments, the pound recovered against the dollar, but is sharply down this year.
Even before the most recent rate hikes, the pound was losing out to the dollar due to the pandemic and the chaos caused by Russia’s invasions of Ukraine, as investors tend to rush to ‘safe haven’ assets in times of uncertainty.
A member of the Bank of England’s rate-setting committee Catherine Mann this week backed boosting interest rates to support the pound. A weaker sterling would add to inflation, she said, as importers find their pounds do not stretch as far.
But James Smith, an economist at ING, said: ‘While we see scope for a 0.5-percentage-point hike in August, we still find it hard to see the central bank taking rates anywhere near as far as the Fed.’
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