Still of Andrew Bailey. File image. Source: FT.com.
Pound Sterling will be supported by the gradualist approach to cutting interest rates at the Bank of England.
The Bank's governor, Andrew Bailey, validated expectations for just four rate cuts in 2025, which the Organisation for Economic Co-operation and Development (OECD) says is appropriate, given expectations for UK inflation to stay above the 2.0% target for the foreseeable future.
In its latest assessment of the UK, the OECD recommended the Bank of England, "maintain the data-dependent restrictive monetary policy stance until inflation is durably around the 2% target."
The OECD thinks the Bank of England's base rate will plateau at 3.5% in 2026 following a gradual interest rate cutting cycle at the Bank of England.
One of the UK's most accurate forecasters, the British Chambers of Commerce, has today said interest rates will fall to 4.0% at the end of 2025, down from 4.75% today, implying just three rate cuts next year. The BCC joins the OECD in thinking the UK's terminal rate will be 3.50% in 2026.
For foreign exchange markets, these are important developments. It means the UK's base rate will lie above the terminal rate for the Federal Reserve, which the OECD expects to be 3.25-3.5%.
It also means UK interest rates will remain well above the Eurozone's, with the OECD expecting the ECB to cut its key rate to 2.0% in late 2025.
"Sterling looks on course to be the best performing major currency of 2024. The outlook for 2025 appears similar in structure and is once again framed by relative growth, and the path and ultimate landing point of the BoE’s easing cycle relative to other major central banks," says Paul Robson, Head of G10 FX Strategy at NatWest.
The Pound to Euro exchange rate is up 4.67% in 2024, and the Pound to Dollar exchange rate is down 0.40%, making Serling the second-best performing G10 of the year after USD.
The Bank of England expects interest rates to be cut at a steady one-per-quarter rate in 2025, which implies four 25-basis point cuts.
Governor Andrew Bailey confirmed this in an interview with the FT this week.
"The Bank of England expects four interest rate cuts next year if its outlook for the UK economy bears out, Andrew Bailey said on Wednesday," reports the newspaper.
The assessment is the latest indication from the Bank that UK interest rates will remain supportive of Pound exchange rates for the foreseeable future.
"In the absence of a major shift in the expected shape of the global monetary policy easing cycle or sharp deterioration in risk appetite, currencies with higher interest rates (carry) are seen trending higher against those with lower yields. Sterling is set to maintain a favourable carry position through ’25 as the BoE stays a 'cautious cutter' while many other central banks remain 'enthusiastic easers'," says Robson.
OECD Chief Economist Álvaro Pereira said the shallower path for rate cuts anticipated for the Bank of England reflects robust domestic demand and extra stimulus from the Budget, which saw Chancellor Rachel Reeve announce the government would be spending more in the coming year than previously assumed.
As a result, the OECD thinks UK inflation will be more robust than previously forecast. The organisation's new inflation projections show inflation won't fall to the Bank of England's 2.0% target in the forecast horizon, ending 2026 at 2.3%.
"Persistent services price pressures will keep core inflation elevated at 3.7% in 2024 and 2.8% in 2025, requiring monetary policy to remain restrictive," said the OECD.
These factors, along with "some strong but not spectacular wage growth", meant the Bank of England did not need to "ease so fast", said Pereira.