‘Inflation fears’ and trade turmoil to reinforce sterling rally
A fresh bout of inflation and Donald Trump’s capricious approach to trade policy should extend the pound’s rally well into next year, according to a top investment bank which has raised its 12-month forecast for sterling against the dollar.
Panmure Liberum’s Simon French said the recent string of hotter-than-expected inflation readings in the UK was likely to force Bank of England officials to adopt a more gradual approach to interest rate cuts, keeping sterling “well supported” into next year.
“The wind is in the sails of US policymakers looking to pursue lowering borrowing costs, with
growing scepticism amongst UK policymakers on whether their easing bias can continue into the final quarter of the year, and into 2026,” French wrote in a note on Thursday. “This should provide a floor under [the pound] and help retain some of the relative sterling strength that has built up [year to date].”
Inflation jumped to 3.8 per cent in July – nearly double the Bank of England’s two per cent target – driven largely by rising food prices, a trend which economists expect to worsen over the rest of the year, leading external rate-setter Catherine Mann to warn of “persistent” inflation bedding.
The more hawkish outlook for UK interest rates comes at a time when the cost of borrowing is coming down across much of the developed world, making the country an international outlier.
Last week, Federal Reserve chair Jay Powell hinted that the US central bank was likely to cut the benchmark rate for the first time since Donald Trump became President at its next meeting in September. Meanwhile, the European Central Bank has embarked on a particularly aggressive round of cuts this year – announcing eight 25 basis point reductions in just a year – which has seen Euro Area interest rate come down to just two per cent.
Sterling gains despite ‘fiscal doom loop’ risks
The UK’s more restrictive monetary policy is likely to drive the pound higher, because the greater yield from holding pounds with a British bank will tend to boost demand.
Panmure Liberum said this “divergence” of central bank policy rates was behind its decision to raise its 12-month forecast for sterling against the dollar from 1.40 to 1.45, extending a rally that dates back to September 2022 when Liz Truss’s fateful mini-Budget sparked a firesale of UK asset classes.
Since then, sterling has risen nearly 25 per cent against the dollar, a trend which latterly has been aided by a global shift away from the greenback in recent months.
Panmure’s French added the UK’s beneficial trading position with the US was also likely to push the UK currency higher, given “the US goods trade balance is in surplus with the UK” and the marginal gains from firms re-routing supply chains to Britain from high-tariff countries.
The bullish prediction comes despite well-documented concerns around fiscal position, which, along with the “increasingly narrow path for escaping a fiscal doom loop”, the bank said presented the “major bear case” for sterling.
But French added: “It is too often overlooked that the public sector debt and deficit path for the UK remains over the near-term at least – relatively favourable in international terms. Exchange rates are of course a relative rather than an absolute metric, so these country benchmarks are more relevant when thinking about currencies than for a range of other assets.”