LONDON (Reuters) - The pound fell half a percent on Thursday as a stronger dollar combined with mounting uncertainty over Brexit negotiations, offsetting the positive impact of bets on a Bank of England interest rate hike next week.
With just over eight months left until Britain is due to leave the European Union, there is little clarity about how trade will flow as Prime Minister Theresa May tries to strike a deal with the bloc.
May on Thursday sought to reassure the public about government plans to stockpile medicines and blood products ahead of a possible no-deal Brexit.
The pound has been vulnerable to Brexit’s to and fro in recent weeks, gaining on hopes May will secure a trade deal that keeps Britain close to Europe and falling on worries the talks will collapse and leave it isolated.
Brexit has overshadowed the impact of monetary policy, the usual driver for currency performance, on the pound.
However, rising expectations of a BoE interest rate rise - the market is currently pricing in an 80 percent chance of a 25 basis point increase at next week’s monetary policy meeting - have helped the currency off 10-month lows hit last week.
But if the BoE does not raise its key rate next Thursday, “that would be a negative signal for sterling in view of current market expectations and as a result the currency would go into free fall,” Antje Praefcke, an analyst at Commerzbank, wrote in a note to clients.
The pound rose to as high as $1.3213 before tumbling as low as $1.3125 in later European trading as the dollar rallied on the back of a falling euro.
Sterling, which has been much less volatile against the euro, firmed 0.2 percent to 88.74 pence against the single currency. The euro was sent lower by the European Central Bank reaffirming that rates would remain as they are through the summer of 2019.
“GBP currently appears to be caught in a battle of wills between Bank of England rate expectations and increasing tail risk hedging as we approach the UK’s departure from the EU on 29 March 2019,” Bank of America Merrill Lynch analysts said in a note.
“While we remain confident of the Brexit end-state, we concede that near-term uncertainty has risen and think markets are unlikely to be as forgiving for a lack of progress in the coming months as they have done over the past year,” the analysts wrote, predicting heightened volatility for the pound.
Reporting by Tom Finn and Tommy Wilkes; Editing by Kevin Liffey