GBP's short-term pressure vs. medium-term promise - DBS

GBP/USD depreciated 0.6% to 1.2990, closing below 1.30 for the first time since August 19. UK CPI inflation fell to 1.7% YoY in September, extending its fall below the official 2% target and fuelling rate cut bets. The Bank of England and the US Federal Reserve are scheduled to meet on the same day on November 7, with both central banks expected to lower their policy rates by the same 25 bps to the same 4.75% level. Despite this, the positive UK-US bond yield spread has narrowed and weighed on the GBP, DBS' FX analyst Philip Wee notes.

GBP's fall is a correction, not a reversal

"Beyond the market's short-term fixation on interest rate differentials, this narrowing should be viewed positively for the GBP in the medium term. First, it reflects that the UK is making better progress compared to its US counterpart in returning inflation to the 2% target. Second, this goal is complemented by the new Labour government's pledge to restore fiscal stability, contrasting sharply with the unsustainable federal debt worries in the next US presidential term."

"Hence, pay attention to the UK 2024 autumn Budget announcement on October 30. In contrast to mini-budget crisis that pummelled GBP to a new lifetime low in 2022 with unfunded tax cuts. UK Chancellor of the Exchequer Rachel Reeves is aiming to balance public spending with progressive taxation. If Reeves succeeds in delivering clear and sensible fiscal discipline, it could boost investor confidence in the UK's economic management."

"GBP/USD should eventually regain its footing when markets recognize that the UK's priority on long-term fiscal stability will best the US's short-term priority on economic growth with stimulus spending. Understandably, the UK's economic growth is expected to improve to 1.3% in 2025 from 1% this year against a US slowdown to 1.7% from 2.3%, with narrower budget and current account deficits than the US."