Growing interest rate gap gives wings to the pound

After a few chaotic years, the United Kingdom is ready to strengthen trade ties with Europe. Dutch export companies may still benefit from a currency advantage.

Due to the significant rise in value in recent weeks, it is tempting to declare 2024 as the year of the dollar. Since the American presidential elections, the currency has increased in value by 5% against the euro. It might even be possible that a euro and a dollar will be worth the same again, just like in 2022. The exchange rate fluctuations of the British pound have been less spectacular lately, but this currency has actually risen more than the dollar this year. Part of this is thanks to a change in leadership in the House of Commons. Since the elections on July 4th, the Labour Party has had a majority there for the first time in fourteen years.

Reversing Brexit?
During this period, under the Conservative Party's leadership, the Brexit referendum took place and the United Kingdom left the European Union after chaotic negotiations. This move is not being reversed for now. However, the Labour government is seeking closer ties with the European Union. Yesterday, Rachel Reeves, the British Minister of Finance, gave a speech to her colleagues from the eurozone for the first time since 2020. She emphasized that after a period of division and chaos, it is now important to strengthen trade ties between the United Kingdom and the European mainland.

Pause for thought
In addition to a normalization of trade policy, the pound is benefiting mainly from a growing interest rate advantage. The European Central Bank (ECB) is expected to lower the policy rate by a quarter percent to 3.0% on Thursday. Economists already anticipate that this rate will decrease in four steps to 2.0% next year. This is how the ECB aims to boost the very low economic growth. On the other hand, the Bank of England (BoE) is more focused on inflation, which was just above the official target in October.

Promising 2025 for the pound
It is highly likely that there will be a pause on the other side during the BoE meeting on December 19th. Currently, the British policy rate is still at 4.75%. This rate is estimated to decrease by two or at most three steps in 2025. The prospect of the interest rate differential with the European mainland widening further makes it attractive for parties to hold their assets in pounds instead of euros. After a strong 2024, the pound may be gearing up for further growth in the new year. This is good news for the Dutch export sector, but a setback for those planning to visit London soon.

Joost Derks

Joost Derks is a currency specialist at iBanFirst with over twenty years of experience in the foreign exchange market. This column reflects his personal opinion and is not intended as professional (investment) advice.

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