By Julien Ponthus
LONDON -Sterling fell to its lowest in two years against a rising dollar on Monday, coming under pressure from data showing Britain's economy unexpectedly shrunk in April and tensions with the European Union over post-Brexit trade with Northern Ireland.
UK gross domestic product contracted by 0.3% after inching down by 0.1% in March, the first back-to-back declines since the early days of the coronavirus pandemic in March and April of 2020.
Britain's growth is already expected to be among the weakest for rich countries in 2023, and there is uncertainty over how fast the Bank of England can raise interest rates to tame inflation without further hurting the economy.
"April's soft GDP figures may quell the appetite of some members to vote for a more aggressive 50bp hike", Investec chief economist Philip Shaw said in a note commenting on the GDP data.
Overall, the central bank is broadly expected to raise interest rates for the fifth time since December on Thursday by another quarter percentage point in a bid to restrain inflation, which it forecast will exceed 10% in the final quarter of the year.
The pound dropped 1.4% to $1.2146, its lowest level since May 2020.
The currency already suffered two straight weeks of losses as strong U.S. inflation data boosted the U.S. currency and expectations of monetary tightening by the U.S. Federal Reserve.
Illustrating the pressure building up across global foreign exchange markets, the safe-haven dollar traded close to two-decade highs against major currencies on Monday amid a sell-off in global stock markets and government bonds.
Adding to the pressure on the pound, the British government was due to present legislation to unilaterally scrap some of the rules that govern post-Brexit trade with Northern Ireland, a move which is likely to inflame a simmering argument with the European Union.
"It's hard to avoid the conclusion that we're heading towards a major clash with the EU that raises the risk of trade war," said Adam Cole, chief currency strategist at RBC Capital Markets, adding that risks were clearly on the downside for the pound.
British Prime Minister Boris Johnson said on Monday that triggering a trade war in response to the new legislation on Northern Ireland trade would be over-reacting but currency analysts warned about negative repercussions for sterling.
"There is the potential for a long-lasting impact on GBP from the current issue", wrote Jane Foley, a strategist at Rabobank, adding "any breach of international law could sour investor sentiment even further".
Against the euro, sterling was down 0.5% at 85.88 pence after briefly touching its lowest level since May 12 against the common currency.
