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Pound Sterling greets 2025 by slumping to a new nine-month low against the Dollar.
Pound to Dollar (GBP/USD) exchange rate broke through a key support line to hit its lowest level since April 2024 at 1.2436.
The fall comes amidst widespread GBP weakness, which is related to a pullback in UK bond yields that is underway. The fall in UK two-year bond yields is a signal that investors are pricing in more interest rate cuts from the Bank of England in 2025 than was anticipated during the closing stages of 2024.
However, it is the determined start to 2025 that the Dollar is putting in where the real FX market story lies.
"The fundamental landscape for the U.S. currency remains the same. A hawkish Fed, scaling back its rate cut projections to signal only two quarter-point reductions by December, resulted in narrowing yield differentials between the US and other major economies, whose central banks began leaning towards a more dovish stance towards the end of 2024," says Charalampos Pissouros, Senior Market Analyst at XM.com.
According to the charts, the next obvious graphical target lies square on the round 1.23 figure:
The breakdown looks to be an extension of a central bank divergence story that has been the dominant trend since October, when stronger-than-forecast U.S. economic data first ignited the Dollar rally.
U.S. economic brilliance prompted a steady reassessment of U.S. interest rate policy, culminating in December's 'hawkish' Federal Reserve guidance. At the same time, the UK economy has slowed, prompting the Bank of England to strike a more 'dovish' guidance at the December policy meeting.
The Federal Reserve cut interest rates in December but indicated it would likely only cut rates on two more occasions in 2025. This puts the Fed firmly in the slow lane regarding rate cuts, which can bolster the U.S. currency.
The Bank of England, meanwhile, kept rates unchanged in December, but three of the nine members of the Monetary Policy Committee voted to cut them, hinting that it might step up the pace this year.
Some analysts think the Fed might just make one more rate cut. This implies that the current trend of lowering rate cut bets can continue to push the Dollar higher, just as the Pound sees forces pulling in the opposite direction.
January is also traditionally a period that favours the U.S. Dollar, meaning it could also benefit from seasonal tailwinds in the opening stages of the year.
Martin Miller, a Reuters market analyst, says the U.S. dollar looks set to rise further in January due to a combination of seasonal, fundamental and technical factors.
"FX traders should note that the dollar is usually in demand at the start of each year. An analysis of the January performance since 2000 of the USD index shows it has risen in 15 of the past 25 years," he says.
Rising U.S. Treasury yields have been a tailwind for the dollar, with the benchmark 10-year note hitting a more than seven-month high last week.
"The USD index, which tracks the dollar against a basket of six major currencies, has scope for an eventual probe of the major 108.962 Fibo, a 61.8% retrace of the 114.78 to 99.549 (2022 to 2023) drop. Fourteen-week momentum remains positive, reinforcing the overall bullish market structure," says Miller.
A move to such highs in the Dollar index would prompt the GBP/USD rate to seek fresh multi-month lows.
Dollar Turnaround Later in the Year
The U.S. Dollar is driven higher by a steady flow of positive U.S. data surprises that push out the need for the Fed to cut rates.
However, with optimism towards the U.S. economy nearing extreme levels and the surprise index at a peak, the prospect of a shift in fortunes now beckons.
A new report from Bank of America (NYSE:BAC) forecasts a divided performance for the U.S. Dollar in 2025, characterised by strength in the first half of the year, followed by a weakening trend in the second half.
The report suggests that the USD will likely remain robust during the first six months of 2025, primarily due to continued US economic growth and the Federal Reserve's moderate approach to easing. However, the analysis indicates that the dollar is overvalued, and this bullish sentiment is widely held.
"Our G10 FX forecasts (ex-JPY & CHF) reflect this ultimate moderation in the USD occurring during H2, after trading close to current levels - on net - though mid-year," says Alex Cohen, FX Strategist at BofA.
The dollar's rally after the US election, driven by expectations of reflationary policies, is expected to wane as the new administration's policy agenda unfolds.
However, according to the report, the market may be underestimating the potential downside risks associated with these policies. Furthermore, the incoming administration's foreign exchange policy could shift as they balance the benefits of a strong Dollar with the advantages of its reserve currency status.
BofA's analysis projects that the USD will moderate in the second half of 2025, with a gradual depreciation.
An original version of this article can be viewed at Pound Sterling Live