What's causing the Sterling to rise?

Sterling has risen by an average of around 4.5% against other G10 currencies this year. In fact, on a global level there are only a couple of currencies that have performed better than the pound. Steve Barrow, Head of Standard Bank G10 Strategy, thinks the strong performance has been based on four main factors.

The first is that the economy has rebounded. For after the recession in the second half of 2023, the economy grew 0.7% in Q1 of this year and 0.6% in Q2 which is more than we’ve seen in the euro zone and even in the US.

The second factor is that interest rates are high in relative terms and the BoE has been slower than many to start cutting.

The third is that UK assets have generally been viewed as undervalued, particularly the stock market.

And the last is that the change in government, after 14-years of Conservative rule, appeared to lift hopes that the economic revival might not only continue but accelerate as business and consumer confidence improved.

Indeed, the fact that Labour quickly sought to end growth-sapping strikes by granting pay rises made it seem that the new government was serious in its aim of lifting annual growth to a target of 2.5%. But now this last source of sterling strength seems to have become the weak link in the chain. It has done so because the optimistic Labour Party rhetoric that we saw in the run up to the July 4^th election, and in the weeks thereafter, has seemingly been replaced by warnings that the fiscal finances are in a far worse state than assumed, implying that the 2.5% growth aspiration could be much further away than originally hoped.

Now undoubtedly Labour is using the old trick here of coming into government and then claiming that the prior administration has left things in a far worse state than they had led people to believe. The Conservatives leadership did exactly the same thing when it first came into office, with the support of the Liberals, back in 2010. But while this tactic might serve the purpose of deflecting the blame for any punitive tax hikes and spending cuts, Steve Barrow thinks there is a danger that it creates an expectations-led downturn in the economy.

In other words, by warning that the country is facing a really tough budget on October 30^th the Labour government could be stymieing productive activity as firms and consumers hold their breath – and close their wallets – until Chancellor Reeves has revealed all the details of the budgetary squeeze next month. Even thereafter, businesses and consumers could shy away from spending and investing for fear that the tough budget will sap whatever strength the economy has mustered in the first half of this year.

Back in 2010, former Conservative Chancellor Osborne presided over a period of fiscal austerity that many today argue did the economy untold and needless harm. The danger today is that the new Labour government is going down the same path. Now we don’t think that this will be the case.

Steve Barrow suspected that the Chancellor won’t turn into some sort of fiscal control freak but, at least ahead of the budget, we can’t be sure and we think that this leads to the risk that sterling gives back some of its strength. At the start of this year the pound was around 1.27 and it has risen to over 1.32, much as we had predicted at the start of the year.

However, in January Steve Barrow forecasted that the pound would go on from here to around 1.36 by the end of 2024, but this could be a stretch now as we envisage that sterling will slide back to 1.25 in coming months for the reasons mentioned above. There is also one additional threat that we think needs to be raised. It is that the UK could see a backlash from Russia if, in the next few days or weeks, the UK, along with the US grants Ukraine the right to use long-range missiles, like the UK’s Storm Shadow, to attack targets in Russia. Up to now only Russian targets inside Ukraine have been permitted. It could prove a notable escalation and if it is one that leads to Russian retaliation the pound could prove particularly vulnerable.