Sterling finds its footing, but Friday will test the recovery
The Pound starts the week with a modest recovery after a difficult second half of September. Its largest fall has been against the US Dollar, while GBP/EUR has also drifted lower. Sterling has held up better against the Australian, New Zealand and Canadian Dollars, showing why the currency on the other side of a payment matters as much as the general direction of the Pound.
GBP/USD fell steadily through the second half of the month before stabilising late last week. GBP/EUR followed a similar, more measured path. Both have opened this week slightly firmer, although a few stronger sessions would not, on their own, undo September’s decline.
What is driving the Pound?
Interest rates remain central to the story. The Federal Reserve raised US rates earlier this month, giving the Dollar support as markets consider whether further increases will be needed. US economic activity has remained resilient, and higher bond yields have made Dollar assets more attractive. That combination has been a major force behind sterling’s fall against the US currency.
The Bank of England held its rate at 3.75%, but three of its nine policymakers voted for an increase. Higher energy costs are adding to UK inflation pressure and could make a further rise more likely. The difficulty is that those same costs squeeze households and businesses. Higher rates can support the Pound, while weaker growth can work against it.
The public finances add to that tension. Long-dated gilt yields remain elevated, increasing the cost of government borrowing ahead of the 28th October Budget. Investors will want to see how the Chancellor balances spending commitments with a credible plan for the public finances. That could matter more for sterling than another change in expectations for Bank Rate.
The Bank has also changed its approach to reducing its gilt holdings. Active gilt auctions are pausing while it considers a future arrangement under which some gilts could be sold to the Government. The proposal has not been finalised. For clients, the relevant point is that both the supply of gilts and confidence in the Budget can affect borrowing costs and, in turn, the Pound.
The Euro has support of its own
The European Central Bank raised rates in September, while euro area inflation has been moving higher. That gives the Euro a separate source of support even if sterling steadies against the Dollar.
Friday’s flash inflation reading will be the next test. A stronger figure, particularly if price pressures are spreading beyond energy, could increase expectations of another ECB rise and weigh on GBP/EUR. A softer result could ease that pressure and give the Pound some room to recover.
For a UK business buying goods priced in Euros, it is important to watch this pair directly. An improvement in GBP/USD will not necessarily translate into a better Euro buying rate. US employment and euro area inflation could send the two pairs in different directions on Friday.
Energy runs through the outlook
Disruption linked to the Middle East has kept oil prices volatile. Higher oil can add to inflation in the UK, US and euro area, leaving central banks under pressure to act even as growth faces higher costs. In the UK, that also feeds into concern about borrowing costs ahead of the Budget.
Oil affects other currency pairs differently. Canada is a major energy exporter, so firmer prices can support the Canadian Dollar and put pressure on GBP/CAD. A sustained easing of tensions could reverse some of these pressures, although the currency response would depend on how markets reassess interest rates at the same time.
Sterling’s relative resilience against the Australian and New Zealand Dollars partly reflects their sensitivity to shifts in global market confidence. When investors become more cautious and the US Dollar strengthens, those currencies can fall further than the Pound. That is why sterling can gain against them while losing ground against USD.
The Yen deserves watching too. GBP/JPY has fallen since the summer, increasing the sterling cost of Yen payments for UK buyers. It is another example of how a broad statement about the Pound can miss what is happening to a specific supplier invoice.
The week ahead
Tuesday brings the Reserve Bank of Australia’s interest rate decision. A rise is widely expected, so the Australian Dollar may react more to what the RBA says about its next move than to the decision itself. UK mortgage lending figures and a ten-year gilt auction are also due.
Wednesday brings revised UK growth figures for the second quarter. An upward revision could help sterling, although this is a further estimate of earlier activity. Australian inflation follows the RBA decision, while US PCE inflation could shift expectations for the Fed.
Friday is the main event for GBP/USD and GBP/EUR. Strong US employment figures could reinforce the case for higher US rates and lift the Dollar, making USD purchases more expensive for clients holding Pounds. Weaker figures could give sterling room to recover. Euro area inflation, released the same day, could move GBP/EUR independently.
Beyond this week, the UK Budget and the Bank of England’s November decision will keep the domestic outlook in focus.
Lamera view
Our near term bias remains cautious on GBP/USD and GBP/EUR, even if both pairs recover some ground after last week’s falls. Friday’s figures could quickly change the direction of either pair, while the Budget is the larger test for confidence in sterling.
There is also a credible route to recovery. Softer US data, easing energy prices or a Budget that reassures the gilt market could each help the Pound. The question for a client with a known payment is whether the potential benefit of waiting outweighs the risk of a higher sterling cost.
If you are buying USD or EUR, it is worth identifying a rate that works for your budget before the market moves. You can then consider covering part of the requirement if sterling improves, while retaining flexibility over the balance. If you are receiving those currencies and converting back into Pounds, recent moves may already have improved your return.
If you would like to talk through an upcoming requirement, please get in touch with the Lamera dealing team.