Pound drops to nearly 2-year low, despite Bank of England lifting key rate to 1%

The Bank of England on Thursday lifted its key interest rate to a 13-year high, but that didn’t help the pound, which tumbled to a two-year low.

By a 6 to 3 vote, the Bank of England opted to lift rates by a quarter point to 1%, its fourth increase in the current cycle, as it seeks to curb inflation. The minority voted to lift rates by a half point.

The pound GBPUSD, -2.07% slid 1.7% to $1.2400, from $1.2636 on Wednesday, hovering at levels not seen since July 2020,and hitting a session low of $1.2362. That’s as traders focused on the somber economic outlook, as well as a divided Monetary Policy Committee. The Bank of England is forecasting the U.K. economy to contract next year.

“Well, when you consider the fact that three MPC members wanted to hike rates by 50 basis points than 25, you would think the pound would rally than sell-off. However, it is worth noting that those three hawks (Haskel, Mann and Saunders) are either external members or leaving, so their votes carry less weight,” said Fawad Razaqzada, market analyst at FOREX.com, in a note to clients.

The U.K. has seen runaway natural gas prices — the lead U.K. natural-gas contract has jumped 168% over the last year — as well as rising wages. The U.K. economy, however, endured a bigger hit from the coronavirus pandemic than either the U.S. or the eurozone.

The Bank of England said it expects inflation to reach 10% this year. That backdrop makes it hard for sterling to appreciate against its international rivals.

“As fears grow that the U.K. is heading for a contraction in output, amid rising prices domestically and abroad, weak growth in eurozone due to the Russia-Ukraine conflict, and China’s lockdowns, this should keep the pound’s upside limited,” he said.

The pound is at risk of hitting $1.20, proven to be a “last line of defense more than once in previous years,” said Alex Kuptsikevich, FxPro senior market analyst, in a note to clients.

The Bank of England has “worsened its economic outlook for 2023, expecting the economy to contract in response to tight financial conditions and the effects of high energy prices. The currency market sees the recession as a notable negative factor, putting pressure on medium and long-term interest rates,” he said.

The Federal Reserve on Wednesday opted to lift rates by a half point, and Australia’s and Brazil’s central bank also have increased rates this week. Norway’s central bank paused but said it’s likely to increase rates again in June.

The yield on the 2-year gilt TMBMKGB-02Y, 1.531% fell 12 basis points to 1.504%.

— Barbara Kollmeyer contributed to this report