The pound has climbed to its highest level against the US dollar since early August driven by investors betting on slower interest rate rises across the pond.
Sterling bounced above $1.22 and was up over 1.2 per cent against the dollar heading into late afternoon trading today.
US Federal Reserve chief Jerome Powell last night said the world’s most powerful central bank will likely slow the pace of rate rises to 50 basis points from 75 basis points at its meeting on 14 December.
It has lifted borrowing costs 75 basis points four times in a row, making US assets relatively more attractive than UK and European bonds and stocks.
Higher interest rates strengthen currencies by increasing returns on assets denoted in said currency.
The Fed’s rate rises have sent the dollar on a tear against nearly all the world’s top currencies this year.
Sterling’s upward move comes after its biggest monthly gain against the greenback in November since July 2020, up around five per cent, building on October’s 2.7 per cent fuelled by Rishi Sunak wiping away the legacy of Liz Truss’s disastrous premiership.
Sterling has defied analysts’ bets on it sliding below parity with the dollar. Those predictions were made in the immediate aftermath of Truss and Kwasi Kwarteng’s mini budget which rocked financial markets by launching £45bn of unfunded tax cuts amid soaring inflation.
Pound/US dollar exchange rate
Sunak and his chancellor Jeremy Hunt have reassured traders by reversing nearly everything in that package and signing off on £55bn of spending reductions and tax increases, most of which will land in a couple years.
Most notably, Japanese investment Nomura said the pound will drop to $0.95 in the days after the mini budget.
Several consultancies have revised up their long term expectations for the pound. Pantheon Macroeconomics now think it will land at $1.15.
Rates on the 10 year gilt edged lower today and have been trading around three per cent for a few weeks. Yields and prices move inversely.
Analysts have however warned sterling is not out of the woods yet.
A coming recession is set to sour investor interest in UK assets, putting the pound and gilts under pressure.
“The current account deficit likely will remain extremely large this winter and throughout 2023, leaving sterling vulnerable to any financial shock that spurs risk aversion,” Pantheon Macroeconomics said in a note.
Britain has run a trade deficit for over a decade. There is a risk it could get worse due to Brexit erecting trade barriers with Europe.
A trade deficit tends to weaken a country’s currency by increasing its supply on international markets. Countries also have to borrow to finance imports, resulting in investors demanding a discount to extend credit.