- The Federal Reserve and the European Central Bank are both expected to hold rates in October, cushioning the pound against new onslaught.
- Concerns about stagflation in the UK and high energy prices are an existential threat to the GBP
- Upcoming UK budget announcement will reveal the level of success of fiscal management and could impact the pound
The British pound’s been on a strong run. On Wednesday, sterling traded near $1.339, almost hitting a one-month high. So far this October, it’s gained almost 2% against the euro and close to 1% against the US dollar.
The pound’s now trading above 1.3400 against the dollar and testing multi-month highs near 1.1850 against the euro. This climb largely comes from changing expectations around central bank interest rates. The GBP/EUR performance against the this month is the best since May 2023. But can this upward trend last?
Where Is GBP Getting Its Strength From?
The pound’s gains stem from solid economic data and high expectations for Bank of England (BoE) interest rate hikes.
UK unemployment fell to 4.7%, and annual regular wage growth held steady at a healthy 3.7%. Strong wage growth like this supports continued consumer spending, which makes the central bank’s job of controlling inflation harder.
Economic growth played a part too. An unexpectedly strong UK GDP report helped pull sterling up from its year-to-date low of 1.3137 against the dollar. The economy grew 0.1% in August, according to data from the Office for National Statistics, exceeding the consensus forecast 0.1%
Will the Pound Hold After Fed and ECB Decisions?
Upcoming central bank meetings could bring some volatility. Most economists expect the Federal Reserve to keep interest rates steady, likely between 3.75% and 4.00%, at its late October meeting, though another hike in December is not out of the question.
The Fed’s decision comes on October 28th. Since an October rate hike now seems improbable, the commentary released with it will matter more than the rate decision itself. A hawkish statement from them could really boost the dollar and pressure GBP/USD.
Similarly, the European Central Bank is also expected to keep rates steady on October 29th. They’ll likely wait to review more economic data before making any policy changes in December.
The pound might hold its ground better against the euro, especially if worries about Eurozone fiscal policy persist. But technical signals hint the currency could be overbought after its strong run in September and October, possibly setting up a short-term correction.
Just a pause in rate hikes from both the Fed and ECB shouldn’t slow sterling’s upward climb much. Still, if there’s any strong sign of more tightening in December, that could shrink the interest rate gap that has helped the pound.
Potential Risks for Sterling
Even with recent gains, big risks remain. The upcoming UK Budget announcement will be a significant focus. If it hints at poor fiscal management or more government borrowing than expected, that could hurt the gilt market and push the currency down. Investors are still wary about debt sustainability given the recent volatility in bond yields.
Concerns about stagflation also persist. Inflation is now outpacing the BoE’s forecasts, and a slowdown in UK economic activity could cap any more gains for the pound.
Persistent geopolitical tensions keep impacting energy prices and complicating the inflation outlook. A big jump in oil or gas costs might force the BoE to hike rates more aggressively, which could then slow economic growth. Conversely, if the BoE holds back, it might erode trust in its inflation-fighting capabilities.
Additionally, the Chancellor’s upcoming budget also brings policy risks. Big tax increases or surprisingly low government borrowing could slow down domestic economic activity. That might prompt the BoE to hit pause on its monetary tightening cycle sooner than expected.
Lower-than-expected unemployment at 4.7% and stronger wage growth of 3.7% recently made a Bank of England rate hike next month feel more likely.
Markets largely expect both the Fed and ECB to keep rates steady in late October. Any further action will probably wait until December, depending on new data.
If the UK Budget signals weaker fiscal discipline or bigger borrowing, it could rattle gilt markets. This might undo recent currency gains, especially because debt sensitivity is still high.