The British pound has experienced a remarkable comeback, defying analysts' predictions to become the best-performing currency among developed economies this year.
This resurgence comes as the sterling peaked against the U.S. dollar in 10 months, closing at $1.26 on Friday, May 5, for the first time since June 2022.
With a 3.3% advance against the greenback since the beginning of 2023, it demonstrates its resilience in the face of adversity.
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But what's the reason behind the British pound defying expectations? One key factor driving the pound's revival is the indication that the UK economy is faring better than anticipated.
Recent estimates suggest that economic activity expanded by 0.1% in the final quarter of last year, surpassing previous expectations of no growth at all.
Furthermore, January saw an estimated increase of 0.3% in gross domestic product, rebounding from a 0.5% decline in December. These positive signs have significantly contributed to bolstering market confidence in the pound.
The Bank of England's commitment to aggressive interest rate hikes has also played a crucial role in the pound's resurgence. Despite concerns about the global banking sector's health, the Bank of England's determination to raise rates has instilled optimism in the market.
Higher interest rates attract foreign investors in search of better returns and strengthen the domestic currency. Additionally, the United Kingdom's inflation rate rose to 10.4% annually in February, further underscoring the necessity of the Bank of England’s tough stance.
The turnaround in the pound's fortunes is noteworthy, considering the currency's sharp decline in September 2022. The unveiling of budget plans by former prime minister, Liz Truss, which aimed to boost borrowing while reducing taxes, led to widespread panic in financial markets and triggered fears of a UK recession.
These concerns were exacerbated by the International Monetary Fund’s prediction of a 0.6% contraction in the UK economy this year, in contrast to slight growth projected for other advanced economies.
Nevertheless, since the beginning of this year, the economic outlook has improved, providing relief and fueling the pound's revival. The sharp decline in energy prices and China's reopening has positively impacted growth expectations in Europe, including the UK.
Currency strategist, Francesco Pesole, explains that the pound's rally has been more pronounced than the euro due to the severity of its declines in 2022.
Both the pound and the euro have benefited from the weakening of the US dollar since its peak in September, as recession fears have emerged in the United States.
Moreover, the uncertainty surrounding the Federal Reserve's next steps has recently restrained the dollar. Speculation has increased that the Fed may pause or halt rate hikes due to concerns about the economy following the failure of Silicon Valley Bank last month.
While experts predict further gains for the pound, caution remains due to the uncertainty surrounding the Bank of England's plans and the potential impact of rate hikes on the country's economy. Currency fluctuations may also be exaggerated in volatile market conditions, as seen at present.
Despite these potential risks, analysts such as Jordan Rochester, a currency strategist at Nomura, anticipate a rise in the pound to $1.30 and even higher.
The remarkable turnaround of the British pound serves as a testament to its resilience and the potential for economic growth, defying expectations and signalling a positive outlook for the UK economy.
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