The surprise market winner of 2024: The Great British Pound
Summary
The pound was mocked as the “Great British Peso” not long ago. Suddenly, it is the best-performing currency in developed markets.
“Credit rates are going up, up, up and the British pound is the envy of the world," exclaims Mr. Banks in the 1964 classic film “Mary Poppins." For the first time since the U.K. chose to leave the European Union, there may be some truth to that statement.
In September, sterling gained more than 1% against a broad basket of trading currencies, according to data from the Bank of England. Year-to-date, it is up 4.7%, thanks to gains of 4.7% and 4.1% against the U.S. dollar and the euro, respectively. This makes the pound the best performer among currencies issued by Group of Ten, or G-10, developed nations. It is now only a hair’s breadth away from reaching its level on the day of the Brexit referendum on June 23, 2016.
This is an important turnaround story for a currency that has been derided by traders over the past few years for being volatile, in contrast to its onetime status as the reserve currency of the world. During this time, it has been dubbed many names in jest, such as the “British lira."
Now, however, it seems difficult to make a case against it.
For one, credit rates in Britain are indeed high and look set to fall at a far slower pace than elsewhere. In September, eight out of nine members of the Bank of England voted to leave benchmark interest rates unchanged at 5%. Right after, the Federal Reserve decided to do a jumbo half-percentage-point cut, leaving U.K. money markets as the highest-yielding in the G-10.
More importantly, markets are pricing in that the BOE will remain more hawkish going forward: Derivatives markets currently suggest that borrowing costs in the U.K. will be set at 4.3% six months from now. In the U.S., they are expected to be below 3.5%.
This divergence seems reasonable on the basis of what British rate-setters have been saying in their policy meetings. Unlike the Fed, the BOE doesn’t appear to be certain that the battle against inflation has been won. This is despite the U.K. having a wobbly job market and a consumer-price index that has stabilized at a rate of growth of around 2.2% year-over-year, compared with 2.5% in the U.S.
To be sure, they are eventually likely to change course and align more closely with other central banks. But the pound will still be the main target of carry traders for quite some time.
Also, a lot of political uncertainty has been lifted since the election of Keir Starmer as Prime Minister back in July. By contrast, the U.S. dollar remains expensive by historical standards and is subject to uncertainty surrounding the November election. Meanwhile, the euro is being weighed down by Germany’s economic woes.
Though Starmer’s center-left government has already stumbled into some political scandals and seems to lack direction in terms of delivering on its economic promises, its moderate profile has been enough to lure back international capital. According to a monthly survey by Bank of America, the U.K. was one of global fund managers’ largest “underweight" positions in May but is now one of their top positive biases.
Cheap valuations are another reason for foreign buyers to dip their toes back. In 2021, American firms looking for megadeals did just that: California-based cybersecurity firm NortonLifeLock—now Gen Digital—announced the acquisition of Avast and Ohio-based manufacturer Parker Hannifin did the same with Meggitt. Ever since, a raft of smaller deals have kept the number of mergers above historical averages: This year’s include International Paper’s bid for DS Smith and a private-equity consortium led by CVC Group saying it will buy “fund supermarket" Hargreaves Lansdown.
In terms of deal sizes in the period between January and September, numbers have been far below the 2021 boom. Still, 73% of the volumes have come from abroad, which is almost as high as back then. This influx of investment helps support the pound.
Stock-market valuations are still at a significant discount to the U.S. in all sectors excluding real estate. The FTSE 100, which is dominated by multinational companies that do worse when the pound is strong, has returned about 6% over the past six months. The more domestically oriented FTSE 250 has yielded about 8%, which is close to the S&P 500’s 10% despite the lack of artificial-intelligence giants.
With investors now making space for the U.K. in their portfolios again, “GBP" may no longer mean the “Great British Peso."
