Sterling hits three-year high against the US dollar after red-hot inflation dampens hopes of interest rate cuts

Sterling hit a three-year high against the US dollar after red-hot inflation dampened hopes of interest rate cuts in the UK.

British inflation rose more than expected in April, hitting a three-month high and striking a tone that could keep pressure on the Bank of England to keep interest rates elevated for longer.

The Office for National Statistics said on Wednesday the consumer price index increased by 3.5 percent year-on-year, up from 2.6 percent in March and the highest reading since January. Economists polled by Reuters had expected an increase to 2.8 percent.

The hotter-than-anticipated inflation sparked a selloff in British government bonds, also known as gilts, and pushed up yields, a measure of borrowing costs, sharply.

The yield on ten-year gilts rose above 4.78 percent, having been around 4.44 percent at the end of last month. The yield on 30-year gilts touched a high of 4.58 percent, compared with 4.22 percent on Friday.

As yields move in the opposite direction to prices, the selloff in gilts pushed up their price.

The increased borrowing costs will have implications for the government’s finances, with higher yields making debt servicing costs more expensive. It could also lead to higher mortgage rates and ultimately stoke fears of a return to a 1970s-style economic crisis, although economists believe such a scenario is unlikely in the short term.

The rise in yields and the selloff in gilts came after the British pound rose to a three-year high against the U.S. dollar on Wednesday as hotter-than-expected inflation kept the door open for higher-for-longer interest rates.

Sterling hit a high of $1.3468 against the dollar, its strongest level since February 2022. It was last trading at $1.3440.

“Sterling has risen amid expectations that the hotter inflation number will make policymakers more inclined to keep interest rates higher for longer,” said Susannah Streeter, head of money and markets at Hargreaves Lansdown.

According to bets in financial markets, there is now just a one-in-ten chance of a Bank of England interest rate cut from 4.25 percent next month with the next move not expected until the autumn.

Earlier this week, the bank’s chief economist Huw Pill said he believed the pace of cuts was “too fast” given the threat posed by inflation.

The prospect of lower rates tends to weaken a currency and push down yields on bond markets.

The rise in pound and gilt yields is a signal that investors think rates will not fall as far or as fast as previously thought.

“We anticipate just one further interest rate cut this year,” said Monica George Michail, economist at the National Institute of Economic and Social Research.

Rising borrowing costs make mortgages, corporate loans and national debt more expensive. Fears are mounting that Chancellor will have to raise taxes this autumn to make her Budget numbers add up.