Sterling strengthened on Thursday in anticipation of a Bank of England (BoE) rate decision, although market activity was still primarily influenced by the fallout from Donald Trump's victory in the US presidential election, which triggered a significant rally in the Dollar.
The BoE is widely expected to announce a rate cut at the upcoming meeting, but the outlook beyond that remains uncertain, especially following last week's budget, which featured high taxes and increased spending.
Economists view the budget as potentially inflationary, complicating future policy direction.
At the time of writing, the Pound was up 0.46% at $1.2939, recovering after experiencing its largest one-day drop against the Dollar since March 2023 the day before.
This decline followed Donald Trump's decisive victory over Democratic rival Kamala Harris, which led investors to shift their focus to US assets likely to benefit from the Republican's “America First” agenda.
Furthermore, in the UK, the Pound and gilts faced pressure last week following the delivery of Finance Minister Rachel Reeves' first budget. The budget included £40 billion in tax increases, along with an additional £70 billion in spending over the next five years, Reuters reports.
The Office for Budget Responsibility (OBR) projects that while economic growth is expected to pick up, inflation will also rise more rapidly in the coming years.
Indeed, according to the OBR's forecasts, consumer prices are expected to increase by 2.6% in 2025, significantly above the Bank of England's 2% target.
“In our view, the OBR projections are way too optimistic. It's the monetary policy report month, and it would be interesting to see if the BoE projections differ from the OBR,” said Jefferies strategist Mohit Kumar.
The OBR's forecast played a significant role in prompting investors to scale back their expectations for repeated interest rate cuts in the coming year.
Inflation in the UK has proven to be more persistent than in other economies, with wage growth and service-sector prices, in particular, showing considerable resilience.
Money markets are currently pricing in a half-point reduction in interest rates over the next three Bank of England meetings, aligning with expectations for the Federal Reserve.
However, this is below the nearly full percentage point expected from the European Central Bank over its next three meetings.
“For the Pound, there is a particular risk that the BoE will be perceived as more dovish than before,” said Commerzbank strategist Antje Praefcke.
“The new forecasts and any indications of future interest rate cuts are likely to be more interesting,” she added.
The expectation that UK interest rates will remain higher for longer, and then decline more gradually than in other economies, has been a key factor driving the strength of the Pound this year.
Consequently, the Pound has emerged as the best-performing major currency against the Dollar, showing a year-to-date gain of 1.65%.