In July, investors believed the Bank of England was on track to raise interest rates to 6% by the end of 2023.
However, signs of a slowing labor market since then and a surprise drop in inflation last month forced traders to change their assumptions.
Last week, the bank kept interest rates unchanged for the first time in nearly two years, and markets now believe borrowing costs have peaked at their current level of 5.25%.
The pound fell sharply after the bank’s latest decision, and has continued to decline since then.
Sandra Horsfield, an economist at Investec, says these changing interest rate expectations have caused “a large part of this overall sterling underperformance”.
“It wasn’t long before markets were still pricing in around 6.5% as the final level of the bank rate,” she says. “That has come back down, and represents a much greater repricing of interest rate expectations than elsewhere.”
However, the weakness of the British pound is also driven by the strength of the dollar. The euro, which was unaffected by the Bank of England’s actions, also fell to its lowest level in six months against the US currency, indicating strength in the US currency around the world.
The euro is now trading at $1,056, after peaking at $1,124 on July 14.
The dollar rose after forecasts published by the Federal Reserve showed that officials expect to keep US interest rates above 5% next year, compared to previous expectations of reducing them to about 4.6%.
The forecasts also show that the world’s largest economy is set to grow by about 2% this year, 1.5% next year, and 1.8% in 2025.
By contrast, the Bank of England expects the UK economy to grow by just 0.5% this year, the same sluggish rate in 2024 and a paltry 0.25% in 2025.