The Pound Sterling is gaining strength against major currencies after the Bank of England (BoE) cut interest rates by 25 basis points, bringing the rate down to 4%. This change is part of the BoE’s monetary expansion strategy that started in August 2024. While four BoE members wanted to keep the rate at 4.25%, one member suggested a larger cut. Governor Andrew Bailey emphasized that the BoE’s approach to easing will be “gradual and careful,” indicating expectations of lower rates in the future.

Economic Pressures and BoE Decisions

Economic challenges have led traders to expect rate cuts from the BoE due to weaker demand in the job market. The labour market is affected by higher National Insurance contributions, announced by Chancellor Rachel Reeves. This year, the BoE increased its GDP forecast to 1.25% and adjusted CPI predictions to 2.7%. The Pound Sterling rose to about 1.3430 against the USD, benefiting from the US Dollar’s decline. Officials from the Federal Reserve are calling for interest rate cuts as the US job market worsens. The market anticipates a 25 bp cut from the Fed by September, potentially bringing borrowing rates to between 4.00% and 4.25%. The GBP/USD pair is strengthening, moving past critical technical levels despite some ongoing negative sentiment. The Pound’s value is influenced by BoE policies and inflation targets.

Focus on the Federal Reserve

Now that the BoE’s rate cut to 4.00% is factored in, our attention turns to the Federal Reserve. The latest US Non-Farm Payrolls report for July revealed only 95,000 new jobs, reinforcing the rationale for a US rate cut. The relative easing pace of the two central banks will be crucial for the GBP/USD exchange rate. The split decision at the BoE indicates that future rate cuts may not follow a clear path and could be unstable. This creates opportunities for trading potential volatility in the pound over the next few weeks. A long straddle strategy, which involves buying both a call and a put option, may allow traders to benefit from significant price changes in either direction. We see potential for further strength in GBP/USD in the short term, currently trading around 1.3430. Futures markets show an 85% chance of a Fed rate cut in September, suggesting the US dollar might weaken further before the BoE’s next decision. Thus, buying near-term GBP/USD call options or taking a small long position in futures could leverage this momentum. However, we need to stay cautious about the UK’s economic softness, highlighted by last month’s increase in unemployment to 4.5%. A similar situation occurred during the 2008-2009 period when coordinated rate cuts by central banks led to sharp currency shifts based on perceptions of economic strength. An unexpected signal from Governor Bailey about a quicker UK rate-cutting cycle would likely limit the Pound’s gains. In the upcoming weeks, our strategy will rely on data, particularly the next inflation and employment figures from both the UK and the US. July’s UK CPI at 2.6% indicates that inflation remains persistent, which may slow the BoE’s ability to cut rates compared to the Fed. This data will influence market expectations and create opportunities in derivatives. Create your live VT Markets account and start trading now.

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