The British pound (GBP) surged to a 2.5-year high against the US dollar (USD) after the Bank of England (BoE) announced its decision to keep interest rates unchanged at 5%. This significant move followed the Federal Reserve’s decision to cut rates, creating a marked divergence in the monetary policy paths of the two central banks. On Friday, GBP/USD reached $1.3330, an increase of 180 pips or 1.4% over three trading sessions.
Key Points:
- Sterling rises to a 2.5-year high against the US dollar.
- The dollar weakens as the Federal Reserve starts cutting rates.
- The Bank of England keeps interest rates steady at 5%.
Bank of England’s Steady Hand
On Thursday, the Bank of England surprised market participants by holding the benchmark interest rate steady at 5%. Many economists had anticipated a rate cut, expecting the BoE to follow a more dovish approach similar to the Federal Reserve. Instead, the UK central bank signaled caution in adjusting monetary policy, emphasizing the importance of controlling inflation before making further cuts.
The steady interest rate policy is a clear response to persistent inflation in the UK, which the BoE aims to bring under control before pursuing rate cuts. Governor Andrew Bailey expressed concern about premature easing, stating, “It’s vital that inflation stays low, so we need to be careful not to cut too fast or by too much.”
Sterling’s Surge
In response to the BoE’s decision, the British pound gained significant ground against the US dollar. Friday’s rise to $1.3330 marked the sterling’s highest level in over two years, continuing a strong performance that has seen the currency climb 5.5% since January. The pound’s strength was largely fueled by the market’s reaction to the BoE’s refusal to cut rates, while other central banks, including the Federal Reserve, are moving in the opposite direction.
This is not the first time in 2024 that the British pound has shown resilience. Despite economic uncertainties and inflation challenges, the sterling has outperformed many of its major counterparts, especially as the US dollar weakens amid the Federal Reserve’s recent actions.
The Fed’s Rate Cuts
Across the Atlantic, the Federal Reserve has taken a different approach. After raising interest rates to their highest level in 23 years, the US central bank has now shifted toward cutting rates to stimulate the economy. On Wednesday, Federal Reserve Chair Jerome Powell announced a half-point rate cut, signaling the start of a rate-reduction campaign that could see rates drop further by the end of the year.
This sharp turn in policy contrasts with the Fed’s earlier stance when it raised rates aggressively in an effort to tame inflation. However, with inflation cooling down, the focus has shifted to economic growth, and the Fed is now expected to cut rates again in the coming months. The US dollar, which had benefitted from the Fed’s rate hikes, is now seeing pressure as investors anticipate more rate cuts, leading to reduced demand for the greenback.
Outlook for GBP/USD
The future of the GBP/USD exchange rate will largely depend on the evolving monetary policies of both the BoE and the Federal Reserve. If the BoE continues to hold off on rate cuts while the Fed proceeds with additional reductions, the pound could see further gains against the dollar.
However, Governor Bailey has cautioned that the BoE will eventually reduce rates as inflation stabilizes, meaning the sterling’s bullish run could face some resistance down the line. The BoE is likely to remain data-dependent, with inflation metrics and economic growth figures guiding future decisions on rate cuts.
Meanwhile, the Federal Reserve’s dovish shift is expected to persist into 2025, which could weigh on the US dollar in the medium term. As a result, many forex analysts are watching the GBP/USD pair closely, predicting potential for further upward movement as long as the current monetary divergence between the UK and US persists.
Conclusion
The British pound’s impressive rise to $1.3330 reflects both the Bank of England’s steady interest rate policy and the Federal Reserve’s shift toward rate cuts. This divergence in central bank strategies has created a favorable environment for the sterling, which has appreciated significantly in 2024. Looking ahead, GBP/USD’s trajectory will depend on how these monetary policies evolve, but for now, the sterling continues to hold a strong position in the forex market.
