This guest article has been written for us by Halo Financial, an award-winning currency exchange and international payment solutions company, and one of our leading business partners.
In this piece, they consider how the Spring Budget last month has affected exchange rates on sterling, and when you might see central banks around the world start to reduce the cost of borrowing.
The recent UK Budget received support from exchange traders
The British chancellor of the exchequer, Jeremy Hunt, cut National Insurance contributions (NICs), and tinkered with a number of other economic levers in his Budget statement on 6 March 2024.
None of his tax and spending plans were ground-breaking and almost every word was leaked ahead of the official announcement in the House of Commons, but his speech was generally met with overall approval by those in the financial markets.
Foreign exchange traders showed their support by pushing the pound up from USD 1.26 to USD 1.2880 in the first week of March.
However, sterling subsequently lost half of that gain in the following week.
Some of those moves were clearly driven by events relating to the US dollar. We know that because the sterling exchange rate against the euro didn’t reflect the same rally and fall.
In fact, it traded in a less than 1% range for the first two weeks of March: just above €1.17 but largely below a major euro buying level at €1.1765.
The Russian invasion of Ukraine drove up interest rates globally
Behind all these rate fluctuations is a nervousness among market participants about the plans that all the central banks have for their base lending rates.
After a decade-long period of virtually zero base rates around the globe, the cost of borrowing started to rise at the end of 2021 in response to the Russian invasion in Ukraine and the effect that had on raw material and food inflation.
For example, the Bank of England (BoE) hiked its base rate from 0.1% to 5.25% through 14 small rises over a period of 21 months.
The European Central Bank (ECB) started its schedule of monetary tightening later and has been less aggressive, with its base rate increasing from 0.5% to 4.5% between July 2022 and September 2023.
The US Federal Reserve did much the same, raising its base rate from 0.25% to 5.25% between March 2022 and July 2023.
The Reserve Bank of Australia’s process was to increase the base rate from 0.1% to 4.35% between May 2022 and November 2023.
Meanwhile, across the Tasman Sea, the Reserve Bank of New Zealand had already started normalising its lending rates in October 2021, bringing the base rate from 0.25% up to 5.5% by May 2023.
Higher interest rates have helped bring down inflation
Having made the cost of borrowing more expensive, central banks have claimed success in flattening out the worst of the inflationary pressures over that period.
However, it’s important to remember that inflation is calculated on a year-on-year basis.
This means that a chart of inflation is, in real terms, little more than a 12-month moving average. It self-corrects by dropping the sharp rises seen in early 2022 as we entered the second quarter of 2023, and this levelling off has brought inflation in most countries down to more manageable level over the last 12 months.
It’s hard to predict when interest rates will start to fall
The quandary that all central banks now face is how to unwind these punitive interest rates without refuelling inflation. They need to address this soon enough to avoid stalling the often meagre and fragile growth that exists in many economies.
This leaves investors and traders with the equally perplexing prospect of second-guessing which central bank will blink first and how quickly others will follow suit.
They are also trying to forecast just how quickly interest rates will correct and where the floor is for the cost of borrowing in the medium term.
This matters because higher base rates generally mean higher yields for investors in interest-bearing instruments like bonds and treasuries. That draws in international investor funds and tends to strengthen the underlying currency.
The UK base rate is among the highest in the G20, and the Consumer Prices Index (CPI) is also stubbornly high, at 3.4% in the year to February 2024. So, although the BoE has some of the greatest scope for an interest rate cut, it may well be the laggard in this company.
New Zealand is also running the comparatively high interest rate of 5.5% but is similarly suffering relatively high inflation at 4.7%. If these two countries hold their base rates at elevated levels for a longer period, wanting to see inflation fall before they act, the pound and the New Zealand dollar may well see a period of strength before they correct.
Conversely, any early rate cuts are likely to weaken the currency of the relevant country.
in essence, ahead of pending elections in both the US and UK, and in advance of any conclusion of hostilities in Ukraine or on the eastern Mediterranean shore, central banks hold the markets in their thrall.
Halo Financial
You can discover more about Halo Financial and the services they offer on their website.
To find out more about how they can help you with your exchange rate queries, please contact Geraldine Collett at Geraldine.Collett@halofinancial.com or call 0207 350 5473.
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Please note
The value of your investments can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
This article is for information only. Please do not solely rely on anything you have read in this article and ensure that you conduct your own research to ensure any actions you may take are suitable for your circumstances. All contents are based on our understanding of HMRC and ATO legislation, which is subject to change.
