The week began with the British pound experiencing some softness against the US dollar, slipping back into the $1.26 range due to increased geopolitical tensions that spurred safe-haven flows. Currently, the pound is struggling to maintain a monthly gain against the dollar, following a cumulative increase of approximately seven cents over the preceding two months.
Despite the heightened tensions in the Middle East, foreign exchange markets have remained relatively calm, and the pound, sensitive to risk, has held up well. This resilience can be attributed to investors scaling back their expectations of monetary easing by the Bank of England (BoE), driven by stronger inflation and positive PMI data this month. The current market sentiment implies around 100 basis points (equivalent to four 25bp rate cuts) for 2024, which is 30-40 basis points less than the projections for the Federal Reserve (Fed) and the European Central Bank (ECB). These optimistic market expectations have contributed to pushing GBP/EUR to levels above €1.17, reaching fresh 5-month highs yesterday. Taking a broader perspective, both GBP/USD and GBP/EUR are trading approximately two cents higher than their 12-month averages of $1.2475 and €1.1519, respectively.
However, we perceive near-term downside risks for the British pound, though these movements seem to be contained, as indicated by low implied volatilities. The upcoming BoE meeting on Thursday could serve as a catalyst if the UK central bank disappoints markets by abandoning its tightening bias and adopting a more dovish stance, evident through the vote split and the accompanying statement.
