Sterling gains on softer U.S. dollar, improved risk sentiment

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Sterling gains on softer dollar

Highlights

Sterling climbs 0.36% to $1.3385 against the U.S. dollar and gains on the euro as risk appetite improves and dollar softens.
Recent foreign direct investment in AI, financial services, and biotech may bolster medium-term pound valuation, offsetting UK public finance concerns, per BofA's Sharma.
The S&P Global Purchasing Managers' Index for Britain's services sector stands at 49.3—higher than the 47.9 flash estimate—signaling economic resilience amid geopolitical risks.

Currency move driven by risk appetite

As reported by Reuters, the pound rises 0.36% to $1.3385 after touching $1.33065 on Monday, its lowest level since May 18. Against the euro, sterling also gains ground, with the single currency down 0.13% at 86.33 pence after earlier falling to 86.27 pence, its weakest since May 26.

The pound is widely seen as a risk-sensitive currency because of Britain's dependence on global trade and capital flows. The dollar softens as investors weigh hopes for a Middle East peace deal and the U.S. interest rate outlook, while global equities rally as traders buy the latest dip in technology stocks.

Sterling had fallen sharply on Friday, mainly because of broad dollar strength as expectations for higher U.S. rates and safe-haven demand increased amid escalating violence in the Middle East. Some market participants now say investor focus is shifting away from political concerns, with sentiment toward the UK economy improving.

UK outlook and policy risks in focus

Kamal Sharma, a foreign exchange strategist at BofA, says investors have remained focused on the UK's fragile public finances while paying less attention to the balance of payments side of the country's so-called dual deficit narrative. He says a more capital-intensive mix of foreign direct investment inflows, including AI-linked investment as well as financial services and biotech funding, should support medium-term pound valuation trends.

Investors are also watching domestic political and economic signals. The June 18 Makerfield by-election could revive fiscal policy concerns if Greater Manchester Mayor Andy Burnham returns to Westminster, potentially opening the way for a leadership challenge to Prime Minister Keir Starmer later this year.

Friday's GDP data is expected to provide fresh clues on the economic outlook. Enrique Díaz-Alvarez, chief economist at Ebury, says a notable upward revision in PMI business indices last week suggests the initial confidence drop was overstated and that the UK economy is proving more resilient to Middle East events than first feared.

The S&P Global Purchasing Managers' Index for Britain's services sector falls to 49.3, although that reading is stronger than the flash estimate of 47.9. Bank of England policymaker Megan Greene said last week that she sees a growing case for raising interest rates as the Iran war drags on and increases the risk of broader price rises across the economy.

In our earlier coverage of the CBI’s downgraded UK growth forecasts, we noted that higher energy costs linked to the Iran war were expected to squeeze household finances and keep the economy on a low-growth path. The CBI also projected inflation peaking higher in early 2025 and unemployment rising to its highest level in more than a decade, while expecting the Bank of England to hold rates steady for an extended period.

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