ExchangeRates.org.uk - The Pound to Dollar (GBP/USD) exchange rate slumped to 8-month lows below 1.2400 on the first trading day of 2025.There is a consensus that US policies will help keep the dollar firm early in 2025.
The domestic and global consequences of Trump’s policies will be a key GBP/USD element this year.
On the US side, UBS is not convinced that economic strength will be sustained and expects GBP/USD gains; “For growth, we see downside to that number given the expected decrease in government consumption and as elevated real rates weigh on gross fixed capital formation.
So the two cuts the market is pricing for 2025 may prove too few.”
It is one of the few bullish investment banks and forecasts that GBP/USD will strengthen to 1.34 at the end of 2024.
ING sees scope for initial Pound resilience, but expects a more aggressive Bank of England policy will weaken the Pound later in the year with GBP/USD ending the year at 1.24.
Danske Bank (CSE:DANSKE) expects sustained dollar support during the year with GBP/USD ending the year at 1.22.
There is a high degree of uncertainty, especially surrounding the impact of US Administration policies under President Trump.
UBS notes the risk of elevated volatility and more extreme developments; “US President-elect Trump’s stated aim of aggressively taxing US consumers via tariffs is an example.
Markets are not pricing in the inflation and growth consequences of policy pledges becoming reality, and assume dilution.
The shift in immigration policy from Trump’s advisor Musk can be cited as a parallel—economic reality tempering political rhetoric.”
There are also multiple geo-political uncertainties including the Russia/Ukraine developments and the Middle East while the Chinese outlook remains a key global uncertainty.
UBS added; “Investors’ assumption that economic reality will limit political extremes is evident elsewhere— China and Germany, for example.
As polarization reduces the middle ground, it is inevitable that markets have to pick a side rather than a compromise.
But if markets pick the wrong side, the economic fallout will be more dramatic.”
The imposition of US tariffs and the reaction, especially for China, could trigger global currency wars and a slide in risk appetite, both of which would have major implications for the Pound.
In this context, investment bank projections for major currencies are relatively narrow and there will be an important risk of much more substantial moves during the year.
ING expects near-term Pound resilience; “The steady increase in US trade tariffs through 2025 stands to weigh on the currencies of the smaller, open economies and the commodity producers.
The outperformers in the G10 space (within a broadly stronger dollar environment) will be the undervalued Japanese yen and – for the first quarter – probably sterling, too.”
Bank of England (BoE) policies will also be very important for the Pound.
There is a consensus that the BoE will cut rates at the February meeting.
Markets are, however, only pricing in two full cuts for the year.
ING expects the BoE will shift to a more aggressive stance later in the year; “We think that softer UK services data will not emerge until February, suggesting GBP/USD may hold onto gains until then.
But ING’s house view is for quite aggressive BoE rate cuts in 2025 – taking the policy rate 150bp lower to 3.25%.
Hence our view for some modest GBP/USD downside later next year.”
Guillaume Derrien, senior eurozone economist at BNP Paribas (EPA:BNPP) is cautious over the UK outlook, “Although the UK economy is facing significant wage pressures, economic activity is significantly less dynamic than in the US.”
MUFG added; "If we were to see the economy in the UK continue to weaken early this year, and the Bank of England started to make noises about potentially being more active in terms of cutting rates in response to that, that could certainly open the door for a weaker pound.”
Derrien added; “Between an ECB whose rate cuts will, admittedly, be gradual but steady, and a US Federal Reserve that is now more hawkish, the Bank of England will be in an intermediate position in 2025, with four rate cuts expected.”
In its December 2024, statement, the Bank of England made reference to uncertainties and vulnerabilities surrounding tariffs and the global economy.
It commented; “Indicators of trade policy uncertainty had increased materially, but that the magnitude and the direction of the impact of any such policies on UK inflation was at present unclear.
These effects might not be apparent for some time.”
US Administration policies will be a key short-term focus with expectations of tax cuts and tariffs.
MUFG examined the historical context; “The price action for the dollar index has been similar so far to following the first US election victory for Donald Trump at the end of 2016 when it also increased by just over 5%.
On that occasion the dollar index peaked right at the start of Trump’s first year in power on 3rd January 2017 before trending lower throughout the first nine months of the year.”
The bank does not expect a repeat of the 2017 price action.
It notes that the global economy strengthened in 2017 which helped underpin global currencies.
MUFG, however, does not expect a repeat this time round with the global economy generally struggling and preventing currencies making headway.
MUFG also expects that the Trump Administration will be much more proactive in imposing tariffs.
It commented; “While we don’t expect 25% tariffs to imposed on all goods imported from Canada and Mexico, it is likely that tariffs will be hiked by a further 10% on imports from China.
More front-loaded tariff hikes support our forecast for the US dollar to strengthen further during the first half of this year.
RBC expects a more moderate stance; “A very heavy hand on tariffs right off the bat would certainly be U.S. dollar positive, but we expect a more conciliatory tone, in the way that those tariffs are implemented in perhaps a more staged way in order to extract as much as possible in negotiations with trading partners.”
There will certainly be concerns that tariffs will undermine global economies.
Upward pressure on domestic prices would also encourage the Federal Reserve to maintain a hawkish stance and resist further interest rate cuts, at least in the short term.
The Fed cut interest rates to 4.50% in December, but there was a hawkish statement.
Markets are not expecting a further cut in January and only pricing in two cuts for the year.
MUFG also expects the hawkish Federal Reserve policy stance will underpin the US currency.
RBC Capital Markets differentiates between different time frames; “We've pushed back our expectation for when that U.S. dollar weakness might materialize.
But we do expect the U.S. dollar to weaken in the longer term, because a lot of the factors that we monitor still argue in that direction.
You've got the U.S. dollar, that is still very overvalued on most models.”
The bank pointed out long-term structural negative factors for the US currency; “We have U.S. trade and fiscal deficits that are quite large and expected to continue for the foreseeable future.
And we've got countries starting to shift away from using the U.S. dollar.”
Scotiabank (TSX:BNS) still expects GBP/USD to be held to 1.24 at the end of 2025 before gains in 2026.
This content was originally published on ExchangeRates.org.uk