GBP: what can be expected in 2024?

Where is the pound sterling headed in 2024? To find out, let’s examine the principal risk factors that could influence the currency market over the coming months, our analysts’ forecasts and key dates to watch.

The main risk factors in 2024

A more dangerous and uncertain world

2024 is the year of localised geopolitical risk. Everything began on 7 October 2023 in the Middle East. Since then, the number of friction points has grown: China/Taiwan, China/Philippines, Iran/Pakistan, Russia/Ukraine, Venezuela/Guyana, and others.

Added to this is an intense electoral cycle. More than 40% of world GDP could change hands at elections:

• The US election on 5 November is a key focus of attention. Its outcome could prove a turning point in the war in Ukraine, for example. But this is not the only important election.

• Municipal elections in Turkey on 31 March will probably be won by the ruling AKP party in Istanbul and Ankara.

• Legislative elections in India in April/May are expected to result in a crushing victory for the party of outgoing Prime Minister Narendra Modi.

• Do not forget European elections and the general election in the UK in the second half of the year, which is likely to see the Labour party return to power.

• Lastly, early legislative elections are probable in Israel, leading to the possible departure of Prime Minister Benyamin Netanyahu – a potential turning point in the conflict.

The world at the end of 2024 will be nothing like the world we know today.

Canals in danger

For decades, it was thought that trading routes were secure, but this no longer holds true. The strait at the entry of the Red Sea, through which 21% of global container trade transits, is not safe to navigate today because of the asymmetric war pitting the Iran-backed Houthi rebels against an international coalition including France. Ships are having to be re-routed through the Cape of Good Hope in South Africa, raising freight costs. But this is not sufficient to rekindle inflation. A report published in January by the Bank of England showed that if the Red Sea route is disrupted throughout 2023, this would only raise annual inflation by a meagre 0.4-0.6 points. That said, it would lead to congestion at ports, as was the case during the Covid crisis, destabilising supply chains, particularly in Europe.

Asia is no longer safe either. Shipping routes in Eastern Asia that cross the Taiwan strait and the South China sea, through which 40% of the EU’s external trade transits, could become more dangerous amid mounting tensions between China and neighbouring countries (Taiwan and the Philippines) over the sovereignty of several islands and atolls. Climate change is another factor to consider.

The Panama Canal is no longer fully operational because of an unprecedented drought.

The safe passage of goods is becoming a structural subject for the markets and the economy. This is new.

A different monetary cycle from others

Policy rates are set to be lowered in 2024. This is the only certainty. But when and by how much? This is where the difficulty lies.

There is big disconnect between market expectations and what central bankers are saying. The money market forecasts around 150-160 basis points of rate cuts on both sides of the Atlantic this year.

Central bankers are more sceptical. Their baseline scenario is 50-75 basis points of rate cuts.

This is a differential of almost 100 basis points. One of the two is wrong. We think it is the money market, which is forecasting an aggressive rate-cutting cycle like those seen in the past. But there is one major difference this time: there is no recession.

Consequently, it does not make sense to slash interest rates. This is the message central banks are conveying. This cycle is different. It will take a little time before the markets revise down their expectations.

At the very least, this implies a revival of volatility in the currency market.

GBP: resilient old girl

Sterling (GBP) has a long experience of geopolitical risk since its creation in the 11^th Century. It has weathered many crises. The latest to date was on 23 June 2016, when the UK made the unexpected choice in a referendum to leave the European Union (EU). Sterling plunged following this vote. Nearly all analysts were forecasting a sustained depreciation of the currency because of the economic upheaval expected to result from Brexit. Some even predicted that sterling could become an emerging country currency.

Eight years later, it must be recognised that this has not worked out as expected. The country has had three Prime Ministers since David Cameron (2010-2016) – a period of unusual political instability for the UK – the Covid crisis, the UK’s effective exit from the EU in 2020, the war in Ukraine in 2022 and rampant inflation (peaking at 11.1% in October 2022), and yet, disconcertingly, sterling remains resilient.

Since the referendum, the pound has moved within a near perfect range of between 0.82 and 0.90. This is a narrow fluctuation range, especially over a period of almost eight years littered with numerous risk factors.

In recent months, the range has narrowed to between 0.85 and 0.88. Objectively, we see nothing that could move the currency out of this zone in the months ahead. We foresee a lateral movement by the UK currency throughout most of 2024.

Monetary policy will not be a differentiating factor. The Bank of England (BoE) and the European Central Bank (ECB) are both singing from the same hymn book. Policy rates (also called short-term rates) need cutting to boost economic activity in 2024. This subject is not up for debate. But these cuts will almost certainly be later and less aggressive than the market anticipates. In the UK, this is explained by the fact that inflation remains too high – both because of inflation in services well above its pre-Covid average and the price-wage spiral. In the eurozone, this is explained by excessive caution towards pivoting monetary policy. The ECB was slow to raise interest rates when these were required to counter inflationary pressures linked to the Covid-era supply-side shock. Today, there is a risk that it will act too late to boost growth at a time when many alarming signals are raising concerns of a recession (recession expected in Germany throughout the year, close to zero growth in France, drop in lending to businesses, etc.). But knowing which of the two will cut rates first is of little importance for the currency market. A lag of several months generally has little effect on currencies.

Geopolitical risk is also unlikely to push sterling out of its trading range. Historically, geopolitics can create more volatility or even trigger a sharp currency depreciation if liquidity is weak (flash crash). But this tends to be an entry point for buyers. We know that the effects of geopolitical risk on the currency market are staggered over time, sometimes even over a few weeks.

Lastly, economic developments are unlikely to cause substantial swings in the sterling exchange rate. Brexit did not lead to the expected crisis. This does not mean there was no collateral damage, such as transport frictions, inflationary effects and temporary shortages of some goods. Overall, however, the UK has retained its attractiveness. The worst is not certain. This is an important lesson. We expect UK growth to reach 0.3% this year versus 0.5% for the eurozone. A twenty base point differential is not sufficient to have any effect on the exchange rate, especially at such weak growth rates. This is really nothing more than a rounding error.

In our view, the impressive stability of His Majesty’s currency is consequently set to continue in 2024.

Key dates to watch

Second half of the year: early general election. Last January, Prime Minister Rishi Sunak, whose favourability ratings are weak because of a string of scandals and weariness with the government, has announced an early general election. The latest polls point to the Conservatives losing power to the Labour party under Keir Starmer, a human rights lawyer. Labour may even obtain an absolute majority in Parliament. This would have significant implications, both for economic policy and international relations. The Labour Party, for example, is far less aligned than the Conservatives with US foreign policy.