Sterling’s Fed honeymoon: Passionate but brief
Sterling enjoyed a short – but significant - fillip following the Fed's surprise inaction on Wednesday, but the U.K.'s bumpy economic recovery soon put paid to the currency's spike.
The pound staged its largest gain against the dollar in three years on Wednesday, after the U.S. Federal Reserve defied expectations by keeping its stimulus program intact.
Analysts had been expecting the central bank to cut its $85-billion-per-month bond-buying program by at least $10 billion. When the Fed's inaction came, the dollar – considered a safe investment in times of economic turmoil – was hit hard. The Fed's continuation of its stimulus program at its current level boosts risk sentiment, and investors keen to get better returns fled the greenback and piled into currencies like the pound.
The market reaction was "fast and furious," according to Forex.com's research director Kathleen Brooks. Sterling rose above $1.60 – to a high of $1.6183 - for the first time since January, and the euro reached levels not seen since February of around $1.3569.
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"The U.S. dollar has weakened sharply across the board following the unexpected decision by the Federal Reserve yesterday not to begin to taper QE (quantitative easing)," said Lee Hardman, currency analyst with Bank of Tokyo-Mitsubishi, in a note on Thursday. "While it remained a close call… the decision came as a big surprise given that the Fed had signaled no discomfort with the consensus view in the market of likely modest tapering heading into the meeting."
This decision not to scale back its stimulus measures had allowed the higher-risk currencies to most notably extend their recent rebounds against the U.S. dollar, Harman added.
But the pound's highs did not last for long, with disappointing retail sales data for the U.K. released on Thursday morning pushing it lower. Sterling slipped 0.3 percent to a session low against the dollar after the figures for August revealed that sales slipped by 0.9 percent month-on-month, in contrast to expectations of a 0.4 percent rise.
The surprisingly weak data contrasts with a string of positive economic releases for the U.K. over the summer, including gross domestic product (GDP) figures showing that Britain's economy grew by 0.7 percent in the second quarter of the year. Last week, Britain's Treasury chief George Osborne insisted that the country's economy was "turning a corner."
Brooks stressed that although the retail figures were disappointing for August, it was mainly due to a one-off scaling back of food sales after a large surge in July, and the annual growth rate remained fairly stable. "Although the headline figures look weak, this retail sales report does not change the overall positive picture for the U.K.'s growth outlook and sales could pick up again for September," she said.
Chris Saint, head of currency dealing at Hargreaves Lansdown, added that despite its slide, sterling remained in a strong position. "Retail sales data took a bit of a shine off the pounds gains, but it's still over $1.60, so it's still really quite buoyant against the dollar," he told CNBC.
Looking ahead, Saint said the apparent divergence between the Fed and the Bank of England's policy positions was key for sterling.
"The dollar's plunge comes at a time when the Federal Reserve's decision to continue adding monetary stimulus puts it in direct contrast with the U.K. central bank, which increasingly looks to have finished its own quantitative easing policies in response to growing evidence of a strengthening U.K. recovery," he said.
The Bank of England's (BoE) Governor Mark Carney announced last month that it would not raise interest rates until U.K. unemployment hits 7 percent, and minutes of the BoE's last policy meeting published on Wednesday revealed that all members of the Monetary Policy Committee had voted against introducing more quantitative easing or raising interest rates.
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"This differential (with the Fed) is supporting sterling against dollar – and should continue to do so. If the U.K.'s economic data continues to be broadly positive, the Bank of England should stay on the back foot," Saint added.
Forex.com's Brooks, however, stressed that there were some potential stumbling blocks for the pound on the horizon.
"Watch out for the debt ceiling and budget debate in the U.S. Congress at the end of this month," she said. "No deal on the budget threatens to shut down the U.S. government. In this scenario we could see dollar gain safe haven flows, reversing some of the Bernanke-inspired weakness."
—ByCNBC's Katrina Bishop. Follow her on Twitter @KatrinaBishop