[IN-DEPTH ANALYSIS] UK: Is Long GBP/USD Still Profitable？

Executive Summary

In the short term (0-3 months), we expect GBP/USD to rise slightly. Here, we emphasize “rising + slight”. In terms of the "rising" view, the UK is less affected by US tariffs, and the Bank of England's (BoE) interest rate cuts are expected to be more moderate than those of the Federal Reserve. These two factors will push the GBP exchange rate higher. In terms of the "slight" view, the recent UK economic data released are mixed. In particular, the disappointing Industrial Production and PMI data are unlikely to support a sharp rise in GBP/USD. In addition, among the major global currencies, the pound has the weakest safe-haven properties. However, the yen has become a typical safe-haven currency due to the carry trade mechanism. Under the influence of the high uncertainty of Trump's tariff policy, it is expected that good and bad news will continue to be released. Therefore, we expect GBP/JPY to face large fluctuations. In terms of other UK assets, we believe that stock and bond prices will rise due to the BoE's continued interest rate cuts.

Source: TradingKey

Source: TradingKey

* Investors can directly or indirectly invest in the foreign exchange market, bond market and stock market through passive funds (such as ETFs), active funds, financial derivatives (like futures, options and swaps), CFDs and spread betting.

1. Forex

Since the beginning of this year, despite fluctuations, the pound has shown an upward trend against the US dollar. The currency pair rose from a periodic low of 1.21 in January to a high of over 1.34 at the end of April. This was mainly driven by both internal and external factors. In terms of internal factors, stronger-than-expected economic data and weaker-than-expected interest rate cuts by the Bank of England have jointly pushed up the pound's exchange rate. In terms of external factors, Trump's tariff policy is shaking the dollar's position as a global reserve currency, causing the US dollar index to continue to fall in recent months (Figure 1.1).

Looking ahead, in the short term (0-3 months), we expect GBP/USD to rise slightly. Here, we emphasize “rising + slight”. In the "rising" view, the UK is less affected by tariffs. Trump called the UK-US trade agreement "the first in a series of agreements". The agreement includes the US exempting the 25% tariff on steel and aluminium products imported from the UK; the tariff on the first 100,000 cars imported from the UK was reduced from 27.5% to 10%; and the UK was granted a tariff-free export quota of 13,000 tons beef to the US. This will be conducive to the rise of the pound as it is less affected by Trump's foreign policy. In addition, due to the continued decline in UK inflation, the BoE may continue its path of interest rate cuts. It is expected that the central bank will cut interest rates twice before the end of this year. At the same time, due to the weakness of the US economy and the lack of a clear reflation trend at present, we expect the Federal Reserve to cut interest rates 3-4 times. The relatively mild interest rate cuts for the BoE will be bullish for the pound exchange rate. In the "slight" view, the recent UK economic data released was mixed. In particular, the disappointing Industrial Production and PMI data are unlikely to support a sharp rise in GBP/USD.

However, in the medium term (3-12 months), as the weakness of the US economy spreads to other countries, the global economic outlook may become bleak. At that time, the safe-haven US dollar index will rise. While recognizing that the Fed’s rate cuts will continue to be negative for the U.S. dollar, we believe that the safe-haven nature of the dollar will outweigh the impact of rate cuts, resulting in negative impact on the GBP/USD exchange rate.

If we shift our perspective from the UK-US to the world, we expect GBP/JPY to face significant volatility (Figure 1.2). The uniqueness of this currency pair lies in the extreme differentiation of its constituent currency attributes. Due to the high openness of the UK's economic structure, the pound has the weakest safe-haven status among the world's major currencies and is a risk currency. On the other hand, the yen has become a typical safe-haven currency thanks to the carry trade mechanism. Under the influence of the high uncertainty of Trump's tariff policy, it is expected that good and bad news will continue to be announced alternately. This will cause the prices of risky assets and safe-haven assets to fluctuate violently. Investors may be able to make profits in turbulent markets through the use of some financial derivatives.

Figure 1.1: GBP/USD and USD Index

Source: Refinitiv, TradingKey

Figure 1.2: GBP/JPY

Source: Refinitiv, TradingKey

* To learn more about the current economic situation and outlook, refer to the final section, "Macroeconomics", in this article.

2. Stocks

From early March to early April, the UK stock market was hit hard by the sharp drop in global stock markets (especially US stocks). After that, the stock market bottomed out and rebounded, recovering most of the lost ground (Figure 2.1). Looking forward, the BoE's continued interest rate cuts may give the economy a tailwind. All these are good for the UK stock market.

In addition, the UK stock market is undervalued. Compared with a P/E ratio of around 28 for the S&P 500, the FTSE 100 has only 18. The recent surge in mergers and acquisitions was good proof that corporate investors had seen the value of the UK stock market (Figure 2.2). At the same time, high dividends also increase the attractiveness of the UK stock market. At a time when trade protectionism is on the rise, investors should pay more attention to Trump's tariff policy. As a long-term and staunch ally of the United States, the UK economy and stock market are less threatened by tariffs.

Figure 2.1: FTSE 100 Index

Source: Refinitiv, TradingKey

Figure 2.2: UK Domestic M&A (£ billion)

Source: ONS, TradingKey

3. Bonds

The yield on the UK's 10-year government bond fell in April and rebounded in May (Figure 3.1). The main reason was that the yield fell in April due to the rise in risk aversion and the expectation of interest rate cuts caused by the increase in global uncertainty. However, in May, with the easing of the trade war and the linkage effect of the global bond market, the yield on UK government bonds bottomed out and rebounded.

Looking ahead, as the BoE continues to cut interest rates, the decline in UK yields is expected to be a general trend. The recent rise is often a good opportunity to buy. It’s worth reiterating here that the main reason we are bullish on UK stocks and bonds is the continued rate cuts by the Bank of England.

In terms of duration, short-end yields have experienced a decline in the past year, and the current price may have priced in the interest rate cut, making it difficult to make any profit. However, the long-end yield has risen instead of falling during the same period, highlighting its investment value (Figure 3.2). Therefore, we believe that long-term government bonds will outperform short-term government bonds in the next few months.

Figure 3.1: UK 10-Year Government Bond Yields (%)

Source: Refinitiv, TradingKey

Figure 3.2: UK Government Bond Yield Curve (%)

Source: Refinitiv, TradingKey

* The Yield Curve is a curve that illustrates the relationship between bond yields and their maturities, commonly used to analyse interest rate levels across different bond terms. The horizontal axis represents the remaining maturity of bonds (e.g., 1 year, 10 years, 30 years), while the vertical axis shows the bond yields. Generally, if the curve's movement is driven by central bank policy rates, short-term (front-end) yields exhibit larger changes. Conversely, if driven by economic fundamentals, long-term (back-end) yields experience greater fluctuations.

4. Macroeconomics

After a weak first three quarters in 2024, the UK economy began to pick up in the fourth quarter of last year. In the first quarter of this year, real GDP grew by 0.7% quarter-on-quarter, making its year-on-year growth rate one of the highest in the past two years (Figure 4.1). This was mainly driven by investment and exports.

Judging from the recent high-frequency data, the current British economy is in a mixed situation. Good news on the demand side has been coming out frequently. With the increase in wages, the year-on-year growth data of Retail Sales has continued to rise since the beginning of this year. BRC Retail Sales Monitor growth in April reached as high as 6.8% (Figure 4.2).

However, the data on the production side is disappointing. After several consecutive months of negative growth, the year-on-year growth of Industrial Production turned positive in February this year, but the latest data in March fell back to negative values ​​(Figure 4.3). In addition, the Composite PMI in April recorded 48.5, which fell from 51.5 in March to the contraction range, among which Manufacturing, Construction and Services PMIs were all below the 50-threshold decline.

In terms of inflation, both Headline and Core CPI have continued to decline towards the target of 2% since the beginning of the year (Figure 4.4). Against the backdrop of the lack of overall economic strength and easing inflation, the BoE cut its policy rate by 25 basis points to 4.25% on 8 May (Figure 4.5). Looking ahead, although the US tariff policy has little direct impact on the UK, the global economic slowdown caused by tariffs has an indirect negative impact on the UK. Therefore, the Central Bank Committee lowered its economic growth and inflation expectations, which indicates that the BoE still has room to continue cutting interest rates.

Figure 4.1: Real GDP (%)

Source: Refinitiv, TradingKey

Figure 4.2: Retail Sales (%, y-o-y)

Source: Refinitiv, TradingKey

Figure 4.3: Industrial Production (%, y-o-y)

Source: Refinitiv, TradingKey

Figure 4.4: CPI (%, y-o-y)

Source: Refinitiv, TradingKey

Figure 4.5: BoE Policy Rate (%)

Source: Refinitiv, TradingKey