Sterling faces challenges in third quarter
The British pound will come under pressure going into the third quarter of the year as interest rate cuts are finally in sight. Meanwhile, the UK general election is expected to bring increased volatility and a weaker pound, with the ruling Conservative Party expected to post its worst performance in decades. Current opinion polls predict that the Labour Party will win the general election on July 4th in a landslide victory, but with spending plans still unclear, investors may steer clear of the pound and pound-denominated assets until there is greater clarity on the economic picture.
UK inflation: Target achieved, but challenges remain
The UK reached a key economic milestone in May, as inflation data pointed to a return to the Bank of England's (BoE) target interest rate. Headline UK inflation fell to 2% for the first time in nearly three years, in line with the BoE's long-standing target. The development marked a notable turning point in the fight against rising price pressures.
Core inflation, which excludes food and energy, also fell to 3.5% from 3.9%, while services inflation fell to 5.7% from 5.9% – moves in the right direction but still worryingly high for the Bank of England.
UK Headline Inflation (YoY)
Source: Trading Economics/ONS
The Bank of England has been vocal in the past few months about its expectation that inflation will reach its target early in the second half of the year. However, it recently warned that CPI inflation is expected to rise slightly in the second half of the year “as last year's decline in energy prices falls out of the annual comparison.” As the Bank of England remains data-dependent, the UK central bank may want to see evidence of further declines, particularly in core and services inflation, before initiating a series of rate cuts.
Now that you have a thorough understanding of the fundamentals influencing the pound in Q3, why not download our full Q3 British Pound forecast to see what the technical setup suggests.
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UK interest rate outlook: expected path and market expectations
The trajectory of UK interest rates continues to trend downwards, with the timing of the initial 25 basis points cut emerging as a key factor influencing sterling performance over the next quarter. Current market valuations can provide valuable insight into potential interest rate adjustments, which could impact the value of the pound against various currencies.
Bank of England meeting on 1 August – Financial markets are currently pricing the likelihood of a rate cut at this meeting at 49%. This balanced outlook suggests a great deal of uncertainty surrounding the Bank of England's immediate intentions.
BoE Meeting on 19th September – If interest rates are left unchanged in August, market indicators suggest that a downward adjustment is almost certain at the September meeting.
Bank of England meeting on 18 December – Markets are expecting a second rate cut before the end of the year to be likely, with a 90% chance of a further rate cut.
BoE's Longer Term Forecast – Looking further ahead, market expectations suggest the easing cycle will continue, with the expected bank rate at the end of 2025 at 4%.
Suggested rates and basis points
Source: Refinitiv Eikon
UK economic growth stalled in April after rising for the previous three consecutive months, again highlighting the Bank of England's difficult balance when considering easing monetary policy. The UK economy is expected to expand by just 0.1% in 2023, the slowest annual growth rate since 2009. Growth in the first three months of 2024 exceeded market expectations, but April's figures were disappointing. UK economic growth forecasts have been revised upwards since the start of the year, with various agencies predicting growth of 0.6% to 1.0% in 2024, but this may be affected by the upcoming UK general election.
UK Growth: May-November 2024
Source: Trading Economics/ONS