British Pound Extends Losses as US Dollar Gains With Fed in Focus

• GBP/USD falls below 1.3350 after reaching highs near 1.3420 last week.
• Ahead of the Fed's decision, traders reduce USD short positions, lifting the US Dollar in quiet trading.
• Expectations of a BoE rate rise in early November are likely to cushion declines in the Pound.
  

Trading just below 1.3350 at Monday's session lows, GBP/USD stands about 0.5% below last week's peak of 1.3419. The British Pound (GBP) is extending its retreat from last week's five-week highs against the US Dollar (USD), as investors reduce USD short positions before the Federal Reserve’s (Fed) monetary policy meeting on Wednesday.

With traders awaiting policy decisions from the Fed and other central banks later this week, market volatility remains relatively subdued. The US Dollar, meanwhile, is on a somewhat firmer footing than in previous weeks.

Near-term Fed and BoE policy divergence supports the Pound

An unchanged monetary policy stance is widely anticipated from the US central bank on Wednesday. Investors have abandoned hopes of consecutive interest rate rises after Fed policymakers called for more time to evaluate the effects of September’s rate increase before tightening policy again.

Expectations of a December increase nevertheless remain strong: futures markets assign an 80% probability to a rate rise of at least a quarter-point. Traders are therefore likely to scrutinise September’s Personal Consumption Expenditures (PCE) Price Index, due on Thursday, for confirmation of those expectations.

Markets have almost fully priced in a 25-basis-point rate rise at next week's Bank of England (BoE) meeting. Recent macroeconomic releases, particularly the unexpected growth in Gross Domestic Product (GDP) and September’s above-forecast Consumer Price Index (CPI), offer ideal conditions for some monetary tightening. This is likely to restrict the Pound's downside.

According to analysts at Societe Generale, GBP/USD is “off five-week highs but up 0.5% this week after 0.7% last week, atypical path pre-budget”, and a “BoE rate increase [is] nailed on in November,” they observe.

In a note, the bank says: “The brace of upside surprises for CPI and PPI output price inflation, and firmer wage data (...) will alert the MPC to the budding risk of second-round effects and will almost certainly trigger a hawkish response on interest rates the next meeting in two weeks.”