Will Pound strengthen further against the US dollar?

The pound has performed quite well since the disaster of the fall to near-parity against the dollar in September 2022. That was when the Conservative PM Liz Truss acted in a very unconservative way with the budget. Sterling is just over 15% higher in broad trade-weighted terms than the September 2022 low, and part of this good performance might be down to the dubious legacy that Truss left.

That legacy was clearly that the markets will punish injudicious budget behaviour and it set a template that both Sunak (the successor to Truss) and new Labour leader Starmer have followed assiduously. The problem, of course, is that fiscal responsibility can mean weak growth. That’s been a curse befalling the UK but the FX market clearly seems to prefer weak growth over fiscal irresponsibility. Just whether the electorate feels the same way is open to question.

The Labour government faces its first significant test in the shape of local elections across parts of the country and a by-election in the seat of Runcorn. Labour won’t be the biggest loser in the local elections as it is defending very few councils. Instead, it will be the Conservatives that get hammered as the Party seems set to lose hundreds of council seats to the Reform Party. The Reform Party is also seen as the odds-on favourite to win the Runcorn by-election, although this may not be such a huge achievement.

The challenge to the incumbent government from the populist right (Reform) is certainly not unique to the UK. It is a familiar story across much of Europe and beyond. This challenge means that more mainstream or even left-leaning parties, such as Labour are leaning into the public gripes that generate support for these sorts of parties. Chief amongst these is the issue of immigration, and, just as other parties in Europe, such as the CDU in Germany, have become more attuned to this theme, so the same is true in the UK.

In essence, it seems that the challenge from the populist right has dragged more mainstream parties away from their traditional base. Labour, for instance, has attempted to stay true to its more left-wing base, while adopting those elements of right-leaning populism that it believes will serve its cause, such as a tough stance on immigration. It has also meant that the Labour government has been pretty lukewarm about re-establishing political and economic ties with Europe after Brexit. The question for the Party, the electorate, and the financial market is whether Labour’s attempts to cover the populist-right base, at least on migration, sullies its more traditional leftist instincts.

On the surface, it might seem that the market welcomes the ‘checks’ on things like fiscal profligacy that are usually derived from right-leaning parties. But as far as Brexit is concerned, we don’t doubt that sterling would rally hard if any sort of return to the EU fold was considered. Critics might argue that the government is not brave enough to upend the policy of nearly a decade and seek a return to the EU fold, just as it is reticent to embrace a more leftist agenda for fiscal policy.

Instead, it has rather looked like the Conservatives in disguise with its barely-altered fiscal rules for budget discipline. It is all in contrast to the US where President Trump clearly seems intent on smashing the economic and political orthodoxy. That he can do so owes much to the US’s dominant global position; something the UK used to have, but does not anymore. Hence UK policymakers have to be far more careful – just as Liz Truss found to her cost in 2022. Except, of course, there might just be some signs that US politicians such as Trump don’t have carte blanche to do what they want without regard for the financial market consequences.

In short, in the Standard Bank’s view, it might just be the case that lessons learnt in the UK, but ignored in the US, could continue to propel the pound higher against the US dollar. When Labour won the election last July, at a time when sterling/dollar was around 1.27, it had a one-year forecast of 1.40. Its one-year forecast today is over 1.50.