British Pound extends losses as US Dollar strengthens, with attention on the Fed

• Can GBP/USD steady below 1.3350 after retreating from last week's highs near 1.3420?
• Quiet trading sees the US Dollar edge higher as traders scale back USD shorts ahead of the Fed's decision.
• Pound declines are likely to remain limited, with the BoE widely expected to raise rates in early November.
  

Selling pressure on the British Pound (GBP) persists as investors reduce US Dollar (USD) short positions before Wednesday's Federal Reserve (Fed) monetary policy meeting. Extending its retreat from last week's five-week highs, GBP/USD touches Monday's session lows just below 1.3350, about 0.5% below last week's peak of 1.3419.

The US Dollar is holding somewhat firmer than in previous weeks, although market volatility remains relatively subdued. Traders are waiting for monetary policy decisions from the Fed and other central banks later this week.

Can near-term Fed-BoE policy divergence support the Pound?

Expectations that the US central bank will keep monetary policy unchanged on Wednesday remain widespread. Before tightening further, Fed policymakers have called for more time to evaluate the effects of September's rate hike, leading investors to abandon expectations of back-to-back interest rate increases.

A December increase nevertheless remains firmly anticipated: futures markets assign an 80% probability to a rate hike of at least a quarter-point. Traders are therefore likely to scrutinise September's Personal Consumption Expenditures (PCE) Price Index, scheduled for release on Thursday, for confirmation of those expectations.

With the Bank of England (BoE) meeting next week, markets have almost fully priced in a 25-basis-point rate increase. Recent macroeconomic releases offer ideal conditions for some monetary tightening, particularly the unexpected growth in Gross Domestic Product (GDP) and September's higher-than-expected Consumer Price Index (CPI). This is likely to restrict the Pound's pullbacks.

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

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.”