Pound slides to $1.358 as Warsh revives Fed hike bets

The pound fell to $1.358 against the dollar as Federal Reserve Chair Kevin Warsh's inflation-first stance revived bets on a 25-basis-point rate hike, pushing the Dollar Index to 99.18.

"Monetary policy does not merely restrain demand; it can also affect the investment and innovation that determine future supply," Joao Gomes, professor of finance at the Wharton School, wrote in a Fortune commentary on the Fed's policy dilemma.

The euro slipped to $1.165 and the yen weakened to 159.44 per dollar, with both currencies heading for their first weekly declines in a month. The Australian dollar bucked the trend, gaining 0.4 percent this week to a three-month high of $0.721, while the Canadian dollar was little changed at $0.722.

With inflation running above the Fed's 2 percent target, traders now price at least one 25-basis-point hike this year. Warsh's Jackson Hole speech at 14:00 GMT Friday is expected to outline his five working groups reviewing Fed operations, but any hawkish signal could extend the dollar's gains and deepen pressure on the pound.

Warsh, delivering his first Jackson Hole address as Fed chair, has made inflation the central focus of his policy framework. Several Fed officials on Thursday renewed concerns about persistent price pressures and showed willingness to raise rates, according to the economies.com report. The dollar index stood at 99.18, just below Thursday's one-week high of 99.26.

The pound's decline reflects a broader repricing of Fed expectations across currency markets. Sterling has now surrendered much of the ground it gained earlier in the month, when markets had been positioned for a more dovish Fed path. In Japan, LSEG data shows a 67 percent probability of a 25-basis-point Bank of Japan rate hike next month, after Tokyo's core inflation accelerated in August and BoJ Deputy Governor Ryozo Himino reiterated the need to raise rates at an appropriate pace. The yen has surrendered some of the gains driven by earlier intervention and is heading for a monthly decline of 1.2 percent.

The AI Investment Dilemma

The Fed's hawkish posture comes as the central bank confronts a $3 trillion AI infrastructure investment boom. Morgan Stanley projects nearly $3 trillion of global AI-related infrastructure investment through 2028, with an estimated $1.5 trillion external financing gap. Gomes argued that reflexive tightening could expose financial leverage while raising the cost of productive investment needed for AI to deliver its expected gains. The investment is already absorbing construction capacity, semiconductors, electricity and skilled labor, which can raise resource utilization and prices in the near term before productivity gains arrive.

"Inflation eventually announces itself. Financial vulnerabilities can remain hidden until they become crises," Gomes wrote. He noted that the Fed's original mandate of financial stability has become secondary to inflation and employment targets, and that the central bank needs better data on how AI investment is being financed. Since 2008, the Fed has invested heavily in understanding banks, housing and mortgages, but the next financial vulnerability is unlikely to resemble the last one, he argued.

The last time the Fed faced a similar productivity-versus-inflation dilemma was the mid-1990s, when Chairman Alan Greenspan resisted tightening despite unemployment falling below what policymakers then regarded as its natural rate. Unemployment continued to fall while inflation remained subdued, and the productivity boom that followed became a reference point for how the Fed should handle technology-driven growth. The question today, Gomes wrote, is how much of that 1990s productivity boom America would have missed if the Fed had continued tightening until the economy conformed to its models.

Market pricing suggests the Fed is more likely to leave rates unchanged through year-end, a scenario that could pressure the dollar. But if Warsh's Jackson Hole remarks reinforce the case for a hike, the pound could extend losses. The next Fed meeting and the BoJ's September decision will be key tests for currency markets, with traders watching for any shift in the dollar's trajectory that could ripple through global risk sentiment.

This article is for informational purposes only and does not constitute investment advice.