The British pound (GBP) has shown resilience in recent trading, closing the week strong against both its European counterparts and the U.S. dollar. This rally comes on the heels of a recent UK budget statement. Since that announcement, there’s been a palpable sigh of relief that has soothed market fears over the prospects of the UK economy. Fortunately, inflation is on a consistent downward trend from recent record highs. Market analysts are forecasting the biggest Bank of England interest rate cut ever, cuts of 0.5% likely scheduled for next week.
The jobs market is still pretty tenuous, and uncertainty about job security is weighing on consumer confidence. While inflation has ebbed, the economic horizon is cloudy at best. For current investors and market participants, hope and worry all lay in equal measure regarding prospects for future growth.
It was the recent UK budget that had the biggest role in strengthening Sterling’s hand. Its announcement helped calm some fears about fiscal policy and helped set a foundation for greater optimism on the pace of economic recovery. Moreover, some mildly positive revisions to the Purchasing Managers’ Index (PMIs) provided even more reassurance. Those revisions showed Britain’s economy was not shrinking as much as many had worried. This good news was clearly positive and certainly helped to support the pound’s broad-based rally.
While fairly dour in general, analysts acknowledged that the recent economic indicators have dramatically changed market expectations. In the past, survey respondents had been expecting a much more clearly signalled deceleration in UK economic activity, which would hurt the currency. The combination of a very positive State budget and much better PMI data has led to a more favorable sentiment.
This decline in inflation has become an important factor in the argument for any cuts to the federal funds rate. With inflation now falling, the narrative has created pressure on the Bank of England to make a knock-on response with monetary policy easings. According to market forecasts, a cut is all but guaranteed next week. Central banks everywhere are reconsidering their playbooks to adapt to changing economic realities.
GBP wrapped up the week with a bang. It beat out all its European counterparts and even beat the dollar. This impressive performance illustrates quite well the short run fiscal multiplier. It reflects a wider mood of guarded optimism about the direction of travel for the UK economy.