GBP/USD edges lower to near 1.2680 ahead of US Fed interest rate decision

• GBP/USD declines on market caution due to the Middle East tension.
• Fed is expected to keep interest rate unchanged at 5.5% in January’s meeting.
• BoE is expected to maintain a prolonged period of restrictive monetary policy to curb inflation.

GBP/USD extends its losses for the second consecutive session on Wednesday, inching lower to near 1.2680 during the Asian session. The risk aversion sentiment is driving Investors towards the US Dollar (USD), which in turn, undermines the GBP/USD pair. US President Joe Biden has communicated that the United States will respond in a tiered approach to a specific situation following the deadly drone attack on US troops near the Jordan-Syria border.

The US Dollar Index (DXY) snaps a three-day losing streak, improving to near 103.60 despite the decline in the US Treasury yields. The 2-year and 10-year yields on US bond notes stand at 4.31% and 4.02%, respectively, by the press time. Moreover, The Federal Open Market Committee (FOMC) is widely expected to maintain its interest rate at 5.5% in its Wednesday meeting.

According to CME’s FedWatch Tool, there is a 43% probability of the Federal Reserve implementing the first rate cut in March. Additionally, there is a 53% chance of a 25 basis points rate cut in May. Investors are expected to closely monitor the US ADP Employment Change data scheduled for release on Wednesday. This data is often viewed as a precursor to the more comprehensive US Nonfarm Payrolls report, which is set to be released later in the week.

The Bank of England (BoE) is expected to keep the interest rate unchanged for the fourth consecutive time in its upcoming Thursday meeting. BoE Governor Andrew Bailey had mentioned in December that there was "some way to go," expressing the central bank's belief that inflation would not return to its 2.0% target until 2025.

Additionally, BoE members have stressed the importance of maintaining a prolonged period of restrictive monetary policy to address inflation concerns. This commitment could contribute to the strength of the Pound Sterling (GBP) and, consequently, limit the losses of the GBP/USD pair.