Sterling stands at risk of renewed weakness as a softer Bank of England tone leaves the currency exposed to looming rate hikes by the European Central Bank and the Federal Reserve and to a politically charged U.K. budget on Oct. 28.
The pound had been a surprise performer among G10 currencies this year, gaining 1.6% against the euro, 2.8% versus the Swiss franc, 4.9% against the Swedish krona and 1% against the Canadian dollar, while trading near-flat with the U.S. dollar and down 1.3% versus the Japanese yen. Ebury’s head of market strategy Matthew Ryan said a "clean and orderly transition of power" had "removed a potential banana skin and eased the perceived political risk premium attached to the pound," and called sterling "the surprise outperformer" over the past three months.
The currency’s resilience has been supported by an unexpectedly firm U.K. economy. Gross domestic product rose 0.4% in the second quarter after 0.6% growth in the first, with consumer spending boosted by sunny weather and World Cup demand and business activity holding up despite geopolitical shocks. Jane Foley, senior FX strategist at Rabobank, noted the pound found extra support at the start of the Iran conflict amid market bets the BOE might respond to rising inflation.
That inflation pressure has re-emerged: headline inflation sits near 3%, and the U.K. remains vulnerable to higher oil and gas costs. The BOE, however, has kept its key interest rate at 3.75% throughout this year and market pricing implies low odds of a September hike. Central bank moves in Europe and the U.S. are widely expected to tighten further in the weeks ahead, a dynamic that typically strengthens those currencies relative to the pound.
Political developments add another layer of risk. Prime Minister Keir Starmer resigned on July 20, leaving the country with its seventh leader in 10 years; Andy Burnham was quickly appointed his successor. New U.K. Finance Minister John Healey said he will remain committed to fiscal discipline while seeking a more even distribution of growth outside London. JP Morgan economist Allan Monks interpreted Healey’s remarks as signalling caution on tax and spending changes given higher borrowing costs.
Ebury’s Ryan warned the Oct. 28 budget carries high political risk and may include "a combination of higher ancillary tax rates and an increase in debt issuance in order to fund Burnham's spending ambitions." Markets will judge any measures that could dent growth or force more borrowing. In that context, dovish messaging from the BOE, especially around its Sept. 17 meeting, would further expose the pound to downside ahead of the new government’s first fiscal test.
