(This story was corrected to change the company name to BNY from BNY Mellon (NYSE: BNY) in paragraph 7.)
By Amanda Cooper and Dara Ranasinghe
LONDON (Reuters) – Sterling hit a one-year high on Wednesday as investors sought higher returns as global interest rates began to fall, but strategists said it would take more than a rate hike for sterling to retain its lustre.
Data on Wednesday showed that UK inflation has been more stubborn than many had expected, prompting traders to cancel their bets on an interest rate cut in August and pushing the pound above $1.30 for the first time since July.
Unlike the euro and even the dollar, the pound has not been affected by domestic politics, but has received a morale boost from the new government that many hope can put an end to years of unpredictable policies and volatile British markets.
Growth in Britain has also started to pick up. On Tuesday, the International Monetary Fund raised its estimate for British economic growth to 0.7% this year, from 0.5% in its last forecast in April.
But at the heart of this recent surge in sterling is the belief that UK interest rates will take longer to fall than elsewhere.
Several major central banks have started cutting interest rates. The Bank of England and the US Federal Reserve are among the last remaining holdouts, although the latest signals from the Fed suggest that September is shaping up as the starting point for lower US interest rates.
“It really depends on what you think is driving sterling — is it a deferral of BoE rate cut expectations or a deferral of Fed rate cut expectations?” said Jeff Yu, chief macro strategist at Bank of New York.
“The fact that cable is above $1.30 and the pound is rising against the euro suggests a re-pricing is taking place.”
Britain’s King Charles on Wednesday outlined Prime Minister Keir Starmer’s plans to revive the economy, with a focus on providing new homes and infrastructure projects.
Demonstrations everywhere
Sterling’s rise was broad-based, pushing the euro, which fell 0.1% to 83.93 pence on Wednesday, to its lowest level in two years.
Sterling is up 2.3% this year against the dollar, putting it in a strong position among major currencies, while the runner-up – the euro – is still down 1%.
On a trade-weighted basis, the pound has recovered all the losses it suffered since the Brexit referendum in late June 2016.
On paper, the background looks more appropriate.
One of the major issues facing Britain is its fiscal position. The UK’s public debt is expected to exceed 100% of GDP, and the government has little room to raise taxes or cut spending.
“We are in the most interest rate-sensitive market I can remember and the latest UK CPI figures do not encourage hopes of a rate cut in August,” said Kit Juckes, head of foreign exchange strategy at Societe Generale.
“I don’t think the pound will go far because the economy doesn’t have a lot of stamina, but there is a lot of uncertainty in the world that there is stability with a new government (and that has helped (the pound),” he said.
A hung parliament in France and political turmoil in the US presidential race, with an assassination attempt on Republican candidate Donald Trump and doubts about the ability of current President Joe Biden to serve another four years in office, have added to the tension in global markets.
The Bank of England is due to meet on August 1, and traders are pricing in less than a 40% chance of a rate cut, compared with around 50% on Tuesday.
UK interest rates are expected to end the year at around 4.75%, down from 5.25%, which is higher than US rates, which are in the 4.50-4.75% range, and eurozone rates, which are around 3.30%.
High interest rates in the UK mean that investors can enjoy higher returns on assets in the UK than they would in any other jurisdiction, helping to cement sterling’s position as a driving force – for now at least.
“Despite the opportunities, we still find it difficult to predict a more significant strengthening of sterling,” said Michael Pfister, Commerzbank strategist, citing uncertainty over the government’s ability to truly turn things around for the economy and the possibility that the Bank of England will adopt a less cautious approach to cutting interest rates.
“Given these risks, we expect the pound to rise slightly. But if these risks turn out to be less likely to materialise, the pound will benefit (more),” he said.