Sterling’s rally has more to go, say Wall Street banks

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The pound is poised for further gains, even after a recent heady period, thanks to a strong UK economy and the Bank of England’s caution on interest rate cuts, investment banks say.

Bank of America and Barclays expect sterling, which is currently trading around $1.3416, to rise to $1.35 by the end of the year. Goldman Sachs has a 12-month price target of $1.40.

The pound has been the best performer of the G10 group of the most heavily traded currencies this year, gaining more than 5% against the dollar and 4% against the euro. It has rallied strongly since late April, when it briefly dipped below $1.23.

On a trade-weighted basis, the pound is at its highest level since the UK’s 2016 vote to leave the European Union and is only around 2% lower than on the eve of the referendum.

The gains were fueled by expectations that UK interest rates will remain higher than elsewhere due to stubborn inflation in services and an economy that has been surprisingly resilient.

“The big picture remains that the UK performed better than expected, the BoE is easing more gradually than other central banks and we may get an improvement in our relationship with (the EU),” said Athanasios Vamvakidis, head global of the G10 FX strategy. at Bank of America.

The bullish outlook from banks comes as sterling rose 0.7% against the dollar on Thursday, taking it to a new two-and-a-half-year high.

“We have raised our sterling target for several months, reflecting our bullish view on sterling,” said Kamakshya Trivedi, head of global foreign exchange at Goldman Sachs.

While investors have increased their bets on central bank rate cuts in recent months amid fears of a US economic slowdown, the swings have been much larger in the US and the eurozone than in the UK.

The Federal Reserve and European Central Bank have each cut half a percentage point so far this year, with about 1.4 and 1 percentage point more cuts in March next year, respectively.

Meanwhile, the BoE cut rates by just a quarter of a point in August, with three or four more such cuts expected over the next six months.

The central bank is reluctant to cut interest rates quickly and risk a burst of inflation. While headline inflation remained close to the 2.2% target in August, services inflation – closely watched by the BoE as a sign of underlying price pressures – rose to 5.6%.

“Inflation is moving in the right direction, but it is still higher than in the euro area and the US,” Vamvakidis said. “Suggests BoE will ease at a slower pace.”

Meanwhile, UK private sector activity grew more than expected in August to the fastest pace in four months, while the OECD on Wednesday forecast the UK would have one of the world’s largest economies fastest growing.

The OECD expects Britain’s gross domestic product to expand by 1.2% in 2024 and 1% in 2025. The Paris-based organization predicted that the US economy would grow by 2.6% this year, while that of Germany will remain with 0.1%.

Lefteris Farmakis, an FX strategist at Barclays, said Britain’s relatively resilient economy and the slow pace of disinflation were part of the reason for the bank’s upbeat sterling view.

He also said the Labor government’s intention to pursue a closer EU-UK relationship could “operate as a positive supply shock further compressing the prime pound for Brexit”.

However, some investors believe that the pound could soon lose ground. “I’ve been generally positive (on sterling) over the last six months, but now we’re getting to levels that make me a bit nervous,” said Geoff Yu, currency strategist at BNY.

Michael Metcalfe, head of macro strategy at State Street, one of the world’s largest custodian banks, said asset managers were “neutral” on sterling.

“We think this most likely reflects doubts that the BoE’s easing cycle will be shallower than the Fed’s, given the better growth outlook for the US economy,” he said.