Sterling Struggles as BoE Holds Rates Amid Inflation Jitters

The pound remained steady on Thursday as the Bank of England is expected to hold interest rates at 5.25%. Despite British inflation falling to 2%, high services inflation means investors expect rate cuts only by August or September. Sterling has experienced fluctuations due to U.S. and European market dynamics.

The pound was little changed on Thursday ahead of a Bank of England (BoE) interest rate decision in which the central bank is expected to hold borrowing costs at a 16-year high of 5.25%.

Data on Wednesday showed British inflation fell to 2%, hitting the BoE's target for the first time since 2021. Yet stubbornly high services inflation means investors expect the bank's monetary policy committee (MPC) to hold rates until August or September, denying Prime Minister Rishi Sunak a boost ahead of a July 4 national election.

The pound was down marginally on Thursday at $1.2712, but up from a one-month low of $1.2658 on Friday. Sterling has been buffeted over the last two weeks by swings in the euro and dollar as investors have digested weaker U.S. inflation data and French President Emmanuel Macron's decision to call snap elections.

The euro was down very slightly against the pound on Thursday at 84.42 pence. It dropped to a two-year low against sterling on Friday as Macron's decision rocked markets, but has since recovered somewhat. Traders think the BoE is most likely to start cutting rates at the September meeting although see a chance of a reduction in August, according to money market pricing.

"The probability of the BoE cutting rates as soon as the August MPC meeting has fallen from around 50-50 to less than one-in-three after the UK CPI (inflation) report revealed that services inflation is continuing to prove more sticky than expected," said Lee Hardman, currency analyst at MUFG. Inflation for services was 5.7% in May, down from 5.9% the month before but above the BoE's expectation of a 5.3% reading.

Hardman said the pound could drop if policymakers make dovish - that is, pro-rate cut - noises in their statement on Thursday.

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