Sterling consolidates with more upside on the horizon!

Sterling consolidates with more upside on the horizon!

The British pound climbed to its highest level since mid-March against the US dollar yesterday, driven by improved global risk sentiment and thin trading conditions due to holidays in the US and UK. GBP/USD is hovering just below the $1.28 mark, nearly 4% above its 2024 low of around $1.23 and just one cent short of its 2024 high. Against the euro, sterling is near nine-month peaks, only 30 pips shy of €1.18 and almost 2% higher than its 2024 low of €1.1560 recorded at the end of April.

The primary factor behind the recent strength of the pound was the hotter-than-expected inflation report published last week, which drastically reduced the probability of a June rate cut by the Bank of England (BoE) from 50% to 10%. Currently, money markets are pricing in fewer than two BoE rate cuts for 2024, with a total easing of 30 basis points expected by year-end, which we consider overly dovish. Consequently, yields on UK Gilts surged to one-month highs, and the UK-US yield spread reached a two-month high, propelling GBP/USD to an 11-week peak.

Election news has not negatively impacted sterling so far, but this could change if polls show the incumbent Conservatives closing the gap, increasing uncertainty. Nonetheless, neither party is proposing radical fiscal policy shifts, and both are likely to avoid spooking financial markets, unlike former PM Truss did in October 2022. Therefore, this election campaign might be less volatile, with the direction of UK assets, including the pound, likely driven more by fundamental economic factors and the timing and pace of BoE rate cuts.

While the spot market has remained relatively calm regarding election news, the options market reflects anticipated volatility, with 2- and 3-month implied volatilities, which cover the election date, spiking higher. The biggest risk to sterling in the coming months, which could push GBP/USD back below $1.25, is a surprise June rate cut by the BoE or a hung parliament in the election, but both scenarios are currently considered tail risks.

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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