BoE’s Policy and Political Shifts Strengthen Positive Outlook for Pound

The Bank of England's (BoE) decision to maintain a hawkish stance last week has further supported the pound’s positive momentum. By sticking to a slower rate-cutting cycle compared to other major central banks, the BoE is helping preserve the pound’s carry advantage. As a result, GBP/USD is holding above $1.33, near 31-month highs and up over 4% year-to-date, while GBP/EUR has surpassed €1.19, approaching 2-year highs and up more than 3% this year.

Beyond monetary policy, the UK government's move toward strengthening EU-UK relations should provide structural support for sterling. However, potential challenges loom ahead, including the upcoming Budget and the risk of anti-growth measures, which could create short-term downside pressure. While the Labour Party's conference this week may offer insights on policy, the market’s main focus will be the Budget on October 30. Attention will also be on the flash PMIs for September, particularly the manufacturing index and service sector price trends, given the significance of services inflation to the BoE.

Absent any significant external shocks, the pound is expected to continue outperforming among G10 currencies in the coming months, with the possibility of GBP/USD reaching $1.35 and GBP/EUR breaking through €1.20.

Fed's Rate Cut Boosts Risk Markets but Signals Fewer Cuts Ahead

The US Federal Reserve’s recent 50 basis point rate cut has bolstered risk markets and high-beta currencies, while also increasing the chances of a soft landing and fewer future rate cuts than anticipated. Despite this, the US dollar index remains anchored near 2-year lows, as the impact of lower rates continues to weigh on the currency.

The Fed maintains that the disinflation trend is intact and has shifted its focus to addressing rising unemployment as the labour market shows signs of weakening. In the immediate aftermath of the decision, the initial risk rally faded after Fed Chair Powell warned against expecting further significant cuts. However, the Fed significantly revised its outlook for US interest rates, projecting lower rates by the end of this year and next. This shift is expected to sustain a positive environment for risk sentiment, benefiting cyclical currencies in the near term.

Euro Underperforms Against US Dollar Amid Weaker Economic Outlook

The euro has lagged behind the pound in its performance against the US dollar this year. This underperformance is primarily due to the Eurozone's weaker economic conditions compared to the UK, coupled with expectations of more aggressive rate cuts by the European Central Bank (ECB) over the coming year compared to the Bank of England (BoE). As a result, despite several attempts, EUR/USD has been unable to sustain a break above the $1.12 level, except for a brief period of six days in July 2023.