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Sterling (GBPUSD=X) is the best performing major currency against the dollar this year as investors prepare for the US Federal Reserve to start lowering rates at a quicker pace than the Bank of England (BoE).
Traders fear a potential tightening of the UK jobs market will slow down the pace of interest rate cuts by the BoE, with the Bank of America (BofA) expecting only one more cut this year, in November.
“We look for four quarterly cuts in 2025, and two cuts in 2026 for a 3.5% terminal rate by mid-2026,” BofA strategist Adarsh Sinha, said.
By contrast, markets are betting on at least three Fed and two European Central Bank (ECB) rate cuts before the end of this year.
The Jackson Hole symposium revealed a stark contrast between US Fed chair Jay Powell’s rate cut greenlight and BoE governor Andrew Bailey’s cautious stance, further compounding market bets that Threadneedle Street will deliver cuts at a slower rate.
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At the conference of central banks, Powell said the “time has come” for the Fed to cut rates, as Bailey warned that it was “too early to declare victory over inflation” in the UK.
The Fed, ECB and the BoE are all set to announce their policy decisions later this month. Threadneedle Street is widely expected to hold its base rate at 5% when it meets on 19 September, after cutting rates for the first time since 2020 in August.
BofA estimated sterling would touch $1.41 by the end of this year as a possible tightening of the UK labour market would give rate-setters reason to ease monetary policy more slowly.
Enrique Díaz-Alvarez, chief economist at Ebury, said: “The British pound continues to put in solid performances and remains the top G10 currency so far in 2024.
“The Bank of England is clearly in easing mode, although the resilience of the UK economy suggests that the pace of MPC rate cuts will be a gradual one.
“Markets are assigning no more than a one-in-four chance of another cut from the BoE in September, though this may change should upcoming data on the labour market, GDP and inflation surprise expectations.”
The UK economy is showing signs of a recovery that could also give the BoE more time before cutting rates again.
The UK manufacturing PMI, which tracks activity across the sector, has hit a 26-month high last month.
The recoveries in output, new orders and employment continued in August, data provider S&P Global reports, lifting the PMI to 52.5 in August, up from 52.1 in July (and matching the flash estimate from mid-August).
Manufacturers also benefitted from easing price pressures, with the rates of inflation in input costs and selling prices both slowing.
Activity was driven by higher domestic demand, while new export orders decreased for the thirty-first consecutive month.
Professor Costas Milas, of the University of Liverpool’s management school said the figures could take pressure off the Bank of England to lower interest rates soon.
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“To understand the implications of this for UK interest rates today and in the near future, one needs to look at the wider context of the latest wage increases. This LSE Business Review blog of mine finds that the latest public sector wage settlements will push up wages in the private (including manufacturing, of course) sector also and eventually add to some inflationary pressures by mid-2025,” Milas said.
“The implication for the BoE is that interest rates should be kept at 5% in September and, from there onwards, the BoE should resist the pace of interest rate cuts financial markets currently expect (markets expect a 4.2% Bank Rate for 2025Q3),” he added.
The latest survey from the Confederation of British Industry (CBI), said private sector growth is expected to rise “modestly” in the three months to November driven by an uptick in services.
However, “consumer-facing businesses are still struggling” while “momentum in manufacturing remains tepid at best”.
The industry trade body said businesses would want to see “policies which can help turn a mixed outlook into a far more positive outcome” from government in the forthcoming autumn budget.
“Whether that’s reducing costs — for instance, through long-overdue business rates reform, or setting out a business tax road map to attract investment. All this can help to deliver the return to long-term sustainable growth that the new government has promised, and firms across all sectors want to see.”
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