GBP/USD drops sharply after BOE raised rates further: what comes next?

The Bank of England hiked the interest rate yesterday, one day after the Federal Reserve delivered a historic 50bp rate hike too. After yesterday’s rate hike, the interest rate in the United Kingdom has reached 1%.

Yet, the British pound dropped across the FX dashboard. So why did traders sell sterling?

Indeed, the decision was hawkish. It was supposed to support the pound, but it did not, even if three Monetary Policy Committee members voted for a 50bp rate hike.

The problem came from what the Bank of England said, not did. It warned markets that the economy is on course to shrink under the pressure of double-digit inflation.

And so, the pound dropped like a rock. Such intense is the pressure on the currency that it drops in an almost vertical line without any meaningful bounce.

Will GBP/USD reverse all of its gains made during the pandemic?

Suddenly, the 2020 COVID-19 pandemic lows are in focus. After the pandemic started, the Federal Reserve slashed the interest rate to the lower boundary and flooded the financial system with freshly printed dollars.

As such, investors rushed to buy risk assets and into selling the US dollar. GBP/USD, in particular, rose by more than 2,000 pips points until it topped at 1.42. It made a double top pattern that was completed in June 2021 before the current bearish trend began.

Ahead of this week’s Bank of England decision, the market evolved in a descending triangle formation. This is a continuation pattern and by the time support in the 1.30 area gave way, the GBP melted.

To sum up, the pressure on the British pound should not ease. By hiking the rates into an upcoming recession, the Bank of England warns that stagflation is gripping the economy.

Stagflation is an economic phenomenon characterized by a period of high inflation and economic slowdown. Economic theory suggests that central banks do nothing, as nothing works – they should just wait for things to adjust by themselves.

But the Bank of England did hike the rates to 1%. If it did more bad than good, then the currency market is the place to reflect it first.