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The Pound’s Positive Outlook Despite Rate Cut Speculation

Possible rate cuts from major central banks like the Federal Reserve, the European Central Bank (ECB), and the Bank of England (BoE) is currently the subject everyone is talking about, and although there are expectations for all three banks to possibly cut rates later in the year, the BoE seems as the most likely to make the first move.

This may appear contrasting to previous expectations that suggested that the BoE was going to be the central bank lowering rates at a slower rate due to its lending rates being higher, however, indicators such as the country’s current inflation, show that the UK’s economy has been improving significantly.

Let’s remember that at this time last year, due to its higher inflation rate, the UK economy was experiencing significantly elevated price pressures relative to its peers in the G10 group. Nonetheless, the country is now standing at a better position as its inflation has lowered  enough to be aligned with the other major economies.

In addition, there was a notestanding development at the BoE’s latest meeting, which caught investors’ attention and further sparked the speculation that a rate cut may be on the horizon. Catherine Mann and Jonathan Haskel, who are two policymakers at the BoE, had previously supported raising interest rates, however, there was a shift in their perceptions and they ultimately advocated for maintaining the current rate. This shift, in which even hawkish members are more dovish, further suggested that the BoE may be indeed making steps towards lowering interest rates.

All three major central banks have suggested potential rate cuts in June, however, since they have not definitively ruled out the option of taking a more conservative approach, there is still a possibility that these cuts may not materialize. Nevertheless, in light of this uncertainty, the Bank of England (BoE) seems less likely to refrain from implementing rate cuts, given its strong economic performance over the past year, and as a response to this, traders and investors have already started to position themselves accordingly, by placing their bets on the BoE taking action.

Now, if the BoE does indeed end up being the first one to cut rates, a pertinent question arises: Will the sterling pound follow the typical pattern of decreasing in value in response to such a move?

Short answer based on recent developments is, not necessarily, and this is because although there has been a slight decrease in bullish pound bets, investors are still optimistic about the pounds future performance due to external factors working in its favor.

Usually, lower interest rates tend to reduce the yield on assets denominated in that currency, making them less attractive to investors seeking higher returns, and because of this investors may seek higher-yielding assets in other currencies. This ultimately can lead to a decrease in demand for the currency of the country implementing the rate cut, in this case, the pound.

Nevertheless, as stated before, investors are feeling pretty confident about the pound’s future outlook, and this is because, for instance the recent drop in energy prices in the UK has had a positive impact on the country’s current account balance. When energy prices go down, the costs of importing energy resources are also reduced, therefore, the UK is able to save money, which in turn strengthens its current account by reducing its trade deficit. This improvement can ultimately support the value of the pound due to the country’s more stable economic position.

Moreover, as we begin April, there is the chance of possibly witnessing a rise in the value for the pound taking into account that over the last 50 years, the pound has typically gained against the dollar in April, with an average appreciation of 0.7%. This month is significant for the UK as it marks the end of the tax year. During this time, individuals often invest in ISAs (individual savings accounts), leading to increased investment activity in the UK, and creating a positive environment for the pound that supports its value. Consequently, there are expectations, such as the ones from the Bank of America (BofA) that suggest that the value of the pound could rise to up to $1.30.

Furthermore, the erosion of yield differentials that have historically influenced the performance of the pound may shift in a way that is growth-positive. This means that even if the yield differential between the UK and other countries decreases, it could be due to positive economic growth in the UK rather than negative factors. And if the narrowing of yield differentials is driven by strong economic performance, increased investment opportunities, or other growth-positive factors in the UK, investors may become more attracted to the pound despite a smaller interest rate advantage. Thus, in this scenario, the pound could strengthen.

Ultimately, while there are still some uncertainties regarding interest rate cuts happening, the discussion about the BoE being the frontrunner in this race, and how the pound would behave in such scenario,  illustrates the importance of considering a wide range of factors when evaluating currency performance. This is because although interest rates do indeed play a significant role, if external economic factors weigh in, they can alter outcomes. Therefore, this serves as a reminder to carry out a comprehensive analysis that takes into account a wide range of variables to better understand and predict future market movements.

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