Interest rate differentials are a key fundamental driver of currency movements, currently favoring the British pound. The real interest rate in the UK stands at 3.25%, higher than the United States' rate of 2.5%. The rising real interest rate in the UK compared to the US is strengthening the pound against the dollar, and this trend may continue to grow.
The possibility of a Fed rate cut in September stands at 90%, with markets predicting multiple rate cuts by the end of the year. In contrast, the likelihood of a rate cut by the Bank of England in August is only 57%, with expectations of less than two rate cuts this year.
Recent weeks have seen improved economic growth prospects in the UK. After a flat GDP growth in April, the growth rate in May was 0.4%, exceeding the expected 0.2% growth. Growth in construction output and a slight uptick in the services sector index have driven the GDP growth, with the services sector index increasing by 1.1% over a three-month period. This could lead to the Bank of England raising its economic growth forecast at the next meeting in August.
It is also possible that inflation forecasts in the UK will be revised upwards. While CPI is expected to be 2% this year and 2.6% next year, an increase in April's living wage may lead to higher core inflation later this year. The new Labour government may look to extend the living wage further, possibly announcing plans in the autumn budget.
The Bank of England has plenty of reason to hold off on a rate cut until after the new government's first budget, which could benefit the pound, especially considering that higher interest rates have not hindered the UK's continued recovery from last year's recession.
If the pound breaks through 1.30 against the dollar in the coming days, it could potentially rise to 1.40, reaching its highest level since 2021.
by ForexInflux
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