A curiosity of markets over the past year or so has been the resilience of sterling. The pound is the best-performing currency among the world’s 10 largest economies in 2024 year to date.
Gareth Gettinby, multi-asset fund manager at Aegon Asset Management, says: “The two big drivers of sterling performance this year have been the different expectations around interest rates, plus the market being slightly more open to owning risk assets, which has led to capital flows into the UK.”
The interest rate differential to which Gettinby refers is the market's view that rates would stay higher for longer in the UK due to inflation persisting at higher levels here than in the US.
As higher inflation would restrict the ability of the Bank of England to cut interest rates relative to the US or Eurozone, that would ensure cash deposits and gilt yields remain higher in the UK than elsewhere, attracting capital into assets.
The point around capital flows is both that capital would come to the UK from overseas to buy the gilts or higher cash deposits, and also has boosted sterling’s value, according to Gettinby.
The increased risk appetite and relatively higher yield offered by UK equities compared with the global market may also have attracted investors to buy UK equities, which would boost sterling’s value.
Gabriella Dickens, G7 Economist at Axa Investment Managers, says: “The BoE was probably caught off guard with the drop in inflation we have seen, their forecasts had been for higher inflation at this point.
"I still think base effects will mean inflation in the UK ticks up later this year. But there is a lot of volatility right now in terms of rate expectations, and the budget will be very important around those expectations.”
More recently, says Gettinby, the market has begun to revise down its expectations for UK inflation, and also reduce the number of rate cuts it expects in the US.
According to Dickens, the combined impact of those is to reduce the interest rate differential between the two countries, which has resulted in sterling weakening against the dollar in recent weeks.
She says the relatively strong performance of the UK economy compared with some Eurozone economies is likely to be supportive of sterling relative to the euro.
Chris Beauchamp, chief market analyst at IG Group, says: “It feels like sterling traders have been buffeted by more than the usual factors. Expectations around what the Federal Reserve and BoE will do seem to have been on a dramatic journey in recent months; first lifting sterling versus the greenback and then dropping it like a stone as first dollar weakness and then sterling weakness take hold.
"Meanwhile, the euro has continued to struggle, hit by the European Central Bank's continued rate cuts and the never-ending parade of bad German data."
