The pound sterling has stormed to a three-year high against the dollar, trading above $1.35 for the first time since early 2022, as global investors pile into UK assets following what the market deems a surprisingly fiscal-disciplined Budget. The rally, which saw sterling gain 1.2% in a single session, reflects a dramatic reversal of the capital flight that had plagued London since the mini-Budget debacle of 2022.
The trigger? A Budget that, against all expectations, did not unleash the usual torrent of borrowing. Chancellor Reeves managed to keep the gilt issuance in check, at least relative to doom-mongering forecasts. The yield on the 10-year gilt actually fell 8 basis points to 4.02%, a clear signal that bond vigilantes are, for now, pacified. This is a market that has been burned by Trussonomics and is now hyper-sensitive to any whiff of fiscal incontinence. The fact that yields dropped suggests investors believe the numbers add up, or at least that the risk of a sovereign debt spiral has receded.
But let us not get carried away. This surge is not a vote of confidence in UK growth prospects. It is a relative play. The eurozone is stagnating, China is reflating with diminishing returns, and the US election looms with its own fiscal uncertainties. British assets, with their perceived stability and rule of law, become the default parking spot for global capital seeking refuge. We have seen this movie before. The pound strengthens, the FTSE 100 gets a bump, but the real economy? That remains sluggish.
What is particularly interesting is the composition of the inflows. The data from the Bank of England shows a sharp increase in foreign purchases of UK government bonds, but also a notable uptick in corporate bond buying. This suggests that the 'sterling carry trade' is back in vogue: borrow in cheap yen or euros, buy higher-yielding British assets. It works until it does not. The moment the Bank of England signals a rate cut, or inflation ticks up again, this hot money will evaporate faster than you can say 'Liz Truss'.
The market is now pricing in a slightly slower pace of rate cuts from the Bank of England, with the first move pushed back to August. That is supporting sterling, but it also means mortgage rates will stay higher for longer, squeezing household budgets. The Chancellor's fiscal headroom, if it exists, is predicated on rosy growth assumptions that have consistently disappointed. The Office for Budget Responsibility's forecasts are, as ever, a work of fiction that no serious investor takes at face value.
What we are witnessing is a classic short-term relief rally. The immediate crisis of confidence has been averted, but the underlying imbalances remain: a current account deficit, a housing market propped up by state intervention, and productivity growth that is the envy of no one. Global investors are not sentimental; they are chasing the next trade. When the US election passes or eurozone data improves, they will pivot again. Sterling at $1.35 is a gift for exporters, but a headache for the Bank of England's inflation target.
The question is whether this surge is the start of a sustained trend or a dead cat bounce. I would bet on the latter. The structural problems of the British economy have not been solved by a single Budget. The yield on the 10-year gilt may have fallen, but it still sits 150 basis points above the German Bund. The risk premium on UK assets remains elevated, reflecting deep-seated scepticism about the country's fiscal trajectory. The only reason foreign buyers are interested is because the alternatives are worse. That is not a ringing endorsement.
So enjoy the rally, but keep your eye on the bigger picture. The market's love affair with sterling is conditional and fickle. One poor GDP print or a surprise uptick in core inflation could send it into reverse. The bottom line is that Britain is still living beyond its means, and the global capital that has flooded in today could just as easily flood out tomorrow.
