Dollar halts six-day rally after Fed hike, sterling slips after BoE stands pat

The U.S. dollar on Thursday paused a six-session winning streak a day after the Federal Reserve delivered an interest rate hike as widely expected. The focus was now on the Bank of England’s move to hold rates steady, while FX desks also geared up for anticipated policy tightening from the Bank of Japan.  

At 15:20 ET (19:20 GMT), the U.S. dollar index, which tracks the world’s premier currency against a basket of six major peers, was just under the flatline at 100.23.

Fed rate hike signals commitment to combat inflation 

The dollar climbed nearly 1.5% over the last six sessions, as odds for a Fed hike mounted. The Federal Open Market Committee (FOMC) on Wednesday lived up to expectations, unanimously voting to raise the federal funds rate to 3.75%-4.00% from 3.50%-3.75%. The U.S. dollar index hit a session high after the decision, as elevated rate environments tend to strengthen the greenback.

Currency market participants also digested hawkish indicators from both the updated Summary of Economic Projections and Fed Chair Kevin Warsh’s press conference. The new dot plot showed at least 12 FOMC members seeing one more rate hike this year.

Warsh, for his part, highlighted a lack of meaningful improvement in underlying U.S. inflation trends, noted that broader financial conditions were not restrictive enough, and re-asserted the central bank’s commitment to deliver price stability.

"The plain fact is that inflation is too high and has been for too long," Warsh told reporters. 

As per the CME FedWatch tool, another quarter-point rate hike in October remains a toss up, with odds of such a move standing at 55%.

Sterling slips after Bank of England stands pat, euro ticks up

Turning to other major currencies, the sterling slipped 0.2% to $1.3356 on Thursday. Earlier the Bank of England’s (BoE) Monetary Policy Committee (MPC) held its key interest rate steady at 3.75% as expected, though three of the nine voting members dissented with the action and preferred a quarter-point hike instead.

The MPC acknowledged that a protracted Middle East conflict had contributed to the United Kingdom’s inflation, but also said there had "been little evidence so far of material second-round effects in price and wage-setting." While there was no direct guidance on any potential rate hikes in the future, the MPC judged that the risks to inflation outlook were titled more to the upside than at the time of July’s meeting.

"Don’t get comfortable. The Bank of England has held rates for the sixth consecutive time, but the markets are increasingly convinced that several rate rises could be in the pipeline. The MPC may have pressed pause on rates, but it’s expected to fast forward from here," Sarah Coles, head of personal finance at AJ Bell, said.

Meanwhile, the minutes of the MPC’s September meeting showed that members believed "financial conditions, and consequently the interest rates faced by households and business, had tightened since the start of the conflict and by further since July."  

According to MUFG, the sterling’s decline was because some traders had expected more aggressive commentary from the BoE. 

"The BoE’s policy update proved less hawkish than some investors had feared, triggering a pullback in both GBP and gilt yields as the MPC stopped short of signaling a November rate hike and continued to stress that tighter financial conditions are already helping to contain inflation," MUFG analysts led by Henry Cook said.

Yen firms as markets prepare for historic BoJ tightening

In Asia, the Japanese yen gained against the dollar, with the USD/JPY pair last down 0.2% to 155.98. The move came a day ahead of a widely anticipated 25 basis point rate hike from the Bank of Japan (BoJ).

Such a move would take Japanese borrowing costs to a 31-year high, marking a dramatic step away from decades of ultra-loose monetary policy as Governor Kazuo Ueda confronts persistent cost-push inflation amplified by triple-digit crude oil prices.

"Yesterday’s Fed decision sets up a fascinating policy dynamic heading into the upcoming (BoJ) meeting," Jeffrey Roach, chief economist at LPL Financial, said. 

"The tension here is that a hawkish Fed and a tightening BoJ are pulling in opposite directions on USD/JPY: a stronger dollar from continued Fed hikes competes directly against a yen that should appreciate as the BoJ normalizes," he said.

"With USD/JPY sitting around 155 heading into the BoJ decision, the net move will hinge on whether the BoJ signals an accelerated pace of hikes. A faster BoJ tightening cycle risks pushing global bond yields higher as Japanese investors repatriate capital in search of better domestic returns, a spillover that could amplify pressure across fixed income markets," Roach added.