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The British pound strengthened modestly on Thursday, outperforming major European currencies and financial markets as investors grew increasingly uneasy about the euro zone’s
economic and fiscal outlook. Capital flows away from euro-area assets helped support UK stocks, government bonds and sterling, while expectations of further Bank of England interest-rate increases provided an additional boost.
Sterling rose 0.1% against the US dollar to $1.34, placing it among the better-performing major currencies, alongside traditional safe havens such as the Japanese yen and Swiss franc.
The pound has also benefited from stronger-than-anticipated UK inflation figures released earlier this week, which reinforced market expectations that the Bank of England could begin raising borrowing costs as soon as November.
Financial markets are now pricing in at least three quarter-point rate increases by April, with the first expected at the central bank’s November 5 policy meeting. By comparison, investors anticipate approximately two increases from the European Central Bank over a similar period.
The growing gap between expected British and euro zone interest rates is making sterling increasingly attractive to investors seeking higher returns. Such strategies, known as carry trades, involve borrowing in a currency with relatively low interest rates and using the proceeds to invest in one offering higher yields. In this case, investors can borrow euros and redirect funds into pound-denominated assets.
European debt concerns weigh on markets
Broader financial-market anxiety has intensified as investors assess the implications of elevated oil prices, the enormous investment required to expand artificial intelligence infrastructure and mounting concerns about whether advanced economies can bring their public debt under control.
European markets have been particularly vulnerable. French government bond yields climbed to their highest levels in 24 years, reflecting growing unease about the country's public finances and the government's ability to implement credible fiscal reforms. Stocks across the euro zone also suffered significant losses.
British assets showed greater resilience. UK government bond yields remained broadly unchanged on Thursday, contrasting with sharp increases in borrowing costs for France, Italy and Belgium.
The UK's FTSE 100 index fell 0.6%, but its decline was smaller than the 1% drop recorded by the pan-European STOXX 600 index.
This relative outperformance suggests that investors are increasingly distinguishing between the risks facing Britain and those confronting parts of the euro zone, even as uncertainty continues to affect financial markets globally.
Sterling extends its advantage over the euro
Recent currency movements underline the divergence between the two European economies' financial-market performance.
Over the past month, sterling has been the strongest-performing major currency against the US dollar, gaining approximately 0.3%. The euro, by contrast, has been the weakest, losing around 2% against the dollar during the same period.
The euro is also heading towards a fourth consecutive weekly decline against the pound. It has fallen a further 0.5% against sterling so far this week, taking its loss for the year to approximately 1.8%.
If the current trend continues, October could deliver the euro's largest monthly decline against the pound since May 2023, when the single currency dropped 2%.
Chris Turner, an ING strategist, said the exchange-rate movement appeared to reflect both renewed strength in sterling and independent weakness in the euro.
Turner noted that the bank had previously expected sterling's gains to prove temporary. However, stronger market confidence in a sustained Bank of England tightening cycle has changed that assessment, making the pound a more attractive high-yielding currency within Europe.
ING expects quarter-point rate increases in November and February, adding to the case for investors to favour sterling over the euro.
French fiscal uncertainty adds pressure
Concerns over France's public finances remain a significant source of pressure on the single currency. Investors are increasingly questioning whether the French government can contain its budget deficit and stabilise its debt burden without undermining economic growth or triggering further political tensions.
These worries have contributed to increasingly negative sentiment towards the euro against sterling. Data from LSEG indicate that options-market positioning has become the most bearish on the euro-pound exchange rate since mid-2024, suggesting traders are increasingly preparing for further euro weakness.
Options markets do not guarantee that the currency will decline, but the shift in positioning highlights the extent to which investors are reassessing the relative outlook for Britain and the euro zone.
UK budget becomes the next major test
Attention is also turning to Britain's domestic fiscal outlook ahead of Finance Minister John Healey's first budget, scheduled for October 28.
Major investors are generally expecting the budget to pass without causing significant disruption to financial markets. Nevertheless, its tax, spending and borrowing measures could influence confidence in the UK's public finances and affect demand for British government bonds and sterling.
For now, the pound is benefiting from a combination of higher expected interest rates, relatively resilient performance in UK financial markets and growing concerns about the euro zone's fiscal challenges.
Whether these advantages persist will depend on incoming inflation data, central-bank decisions and the ability of European governments to restore investor confidence in their public finances.
