Sterling fell to a record low last autumn as investors rebelled against former prime minister Liz Truss’ budget plans. She is now enjoying a comeback.
The pound hit its highest level against the US dollar in 10 months on Tuesday, topping $1.25 for the first time since June 2022. The pound, which has advanced about 3.3% against the dollar since early of 2023, is the best performing currency among developed economies this year.
The UK currency has been boosted by signs that the country’s economy is performing better than expected. Activity is now believed to have expanded by 0.1% in the final three months of last year, compared with a previous estimate of no growth. Gross domestic product growth in January was estimated at 0.3% after falling 0.5% in December.
This resilience is driving expectations that the Bank of England will maintain aggressive interest rate hikes despite concerns about the health of the global banking sector. Raising rates can boost the domestic currency because it helps attract foreign investors seeking higher returns.
Inflation in the UK also jumped to an annual rate of 10.4% in February, underscoring the need for the Bank of England to maintain its hawkish stance.
The pound plummeted near $1.03 in September 2022 after the Truss government unveiled plans to increase borrowing while cutting taxes, sparking panic in financial markets that fueled fears of a recession in the United Kingdom.
The International Monetary Fund predicted in January that the UK economy would contract 0.6% this year, while all other advanced economies would grow, if only slightly.
“There was a lot of pessimism reflected in the price of the pound,” said Francesco Pesole, currency strategist at ING.
But the sharp drop in energy prices and the reopening of China have provided some relief on the economic outlook since the beginning of the year.
“There was a big revaluation of growth expectations in Europe, and that affected the United Kingdom,” Pesole said.
The euro has also been boosted by this dynamic, rising 2.3% against the US dollar in 2023. The pound’s rally has been more pronounced largely because its declines in 2022 were more severe, according to Pesole.
Both currencies have been helped by the dollar’s sharp decline from highs reached last September as recession fears have filtered into the United States.
The lack of clarity over the Federal Reserve’s next steps has also restrained the dollar in recent weeks. Investor speculation has increased that the Federal Reserve could pause or stop rate hikes due to concerns about the economy following the bankruptcy of Silicon Valley Bank last month.
Jordan Rochester, currency strategist at Nomura, said he believes the pound could rise to $1.30 this year and “potentially higher.” But he still sees risks given the uncertainty surrounding the Bank of England’s plans and how rate hikes will impact the country’s economy. And Pesole warned that currency fluctuations are often exaggerated when markets are choppy, as they are now.
“In a volatile market environment, movements are exacerbated,” he said.