Why has the pound started to fall back?

Why has the pound started to fall back after such a strong run this year? The Standard Bank thinks that a lot can be left at the door of policymakers. On the monetary policy front, it has been arguing for some while now that the Bank of England has been far too timid with its rate cuts. That might seem controversial given that the Bank has cut rates four times in the past year for a total of 100-bps. It might also seem a questionable view when inflation has bounced back up from the 2% target this year and is seen holding at 3.4% when the June data are released on Wednesday.

However, the UK economy is melting away fast after a reasonable start to the year. Monthly GDP fell in both May and June. That points to negative growth in Q2, and if there’s another to follow that, it would put the economy in recession. While we’re not convinced that this will happen, the recent data still leaves the BoE’s decision to increase its 2025 GDP forecast from 0.75% to 1% in May looking a little hopeful.

BoE Governor Bailey admitted in an interview that slowing growth and a cratering of the labour market could open up sufficient spare capacity in the economy to warrant bigger rate cuts. This is exactly what we think is going to happen. The market remains priced for the BoE to take rates down at a pace of around once per quarter until the base rate drops to around 3.5%.

“We see a faster pace than this and a base of 3%. On its own a drop in base rates like this might be expected to weigh on the pound. But we feel that rate cuts could be particularly detrimental to the pound if they occur against the backdrop of inflation that is still above target. For while we do see inflation easing back from current levels over time, we suspect it will be modest and will leave some in the market fearing that the Bank is playing a bit fast and loose with policy”, said the Standard Bank.

It is not just monetary policymakers that have struggled. Those with the fiscal reins have had a tough time as well. It has reached a point where Labour’s attempts to curb spending in areas such as welfare are being curbed by its own politicians. This is despite the fact that the government should really be able to push policies through parliament thanks to its huge majority of 165 seats. The result is that budget deficit consolidation has had to come through tax increases; something that slows the economy and may ultimately mean that achieving the fiscal targets proves harder, not easier.

Even the tariff ‘win’ for the government compared to other countries was not much of a win as there is still a 10% blanket tariff on UK exports to the US, which is the same as it was before the trade deal with the US was struck, and much higher than the effective tariff rate that was prevailing before Trump came to power.

In short, confidence in government policymaking seems to be at a low ebb, just as we’d argue it is for the Bank of England as well. While this is expected to weigh on the pound, we do have to bear in mind that everything is relative. For if confidence in UK policymaking appears pretty fragile, the same can be said about US policymaking. At least the UK government has fiscal targets, however difficult to achieve. The US has none. At least the Bank of England does not have government policymakers berating it for refusing to cut base rates faster. The same is not true for the Fed.

In other words, if we feel that the root of the pound’s demise is down to market concerns over policymaking, sterling should be ‘safe’ against the US dollar even if it is vulnerable elsewhere. So, while we do see sterling/dollar moving up into the 1.40-1.50 range over the next year, or two, that’s most likely to come in the context of a slide against other currencies such as the euro, Swiss franc, yen and more and that, in turn should mean that sterling’s trade-weighted value declines some more.