The British pound surged to a two-year high against the dollar on Tuesday, bolstered by expectations that the Bank of England (BoE) will cut interest rates less
aggressively than the Federal Reserve, alongside signs that the UK economy is outperforming the eurozone.
Sterling climbed as high as $1.3246, its strongest level since March 2022, before settling at $1.3222, marking a 0.25% increase for the day.
The dollar has faced downward pressure in August as traders grow more confident that the Federal Reserve will implement significant rate cuts this year, with the pound emerging as one of the beneficiaries of this trend.
Markets are currently anticipating 100 basis points of cuts across the Fed's remaining three meetings this year, compared to around 40 basis points for the BoE, although the BoE did implement a rate cut in August.
Bank of England Governor Andrew Bailey emphasized on Friday at the Kansas City Fed's annual economic conference in Jackson Hole that further interest rate cuts would not be rushed, as it is still too early to confirm that inflation has been fully contained.
In contrast, Federal Reserve Chair Jerome Powell, speaking at the same event, signaled that "the time had come" for U.S. interest rate cuts.
"There was certainly a more cautious tone to Bailey's speech compared to Powell's," said Derek Halpenny, head of research for global markets EMEA at MUFG, in a note to clients.
British inflation, which has slowed to around the BoE's 2% target despite persistent high prices in services, is also playing a role.
"The quicker drop in inflation, combined with the expected caution from the BoE, suggests that the BoE could maintain the most attractive real policy rate among G10 currencies by mid-next year. This will likely continue to support the pound," Halpenny added, noting that MUFG plans to adjust its sterling forecast upward.
The pound also strengthened against the euro, with the common currency falling 0.27% to 84.45 pence, its lowest level since August 1.
Analysts at UBS believe that domestic economic developments in the UK will continue to support the pound, contrasting with "still-subdued European economic data." They have set a target of 83 pence for the euro-pound pair by year-end.