Pound Lines Up a Rebound From Early 2025 Hit

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Pound Sterling unexpectedly plummeted in early 2025 trade, but some analysts don't think the move will persist.

Losses for the Pound followed news of a decline in the UK manufacturing PMI and another rise in wholesale gas prices to two-year highs.

The developments confirm the UK economic outlook in 2025 will be challenging, but this is not new news, and the move by the Pound far exceeds what would have been expected given the second-tier nature of these developments.

Kyle Chapman, FX Market Analyst at Ballinger Group, says the Pound has taken "a hit... moves like we are seeing today rarely persist and FX is detaching from rate spreads."

If this is the correct assessment, the Pound could find itself targetted by dip buyers in the coming days, which could help it recover.

The decline in GBP at the start of the year, "speaks to forced hedging and hedge rebalancing rather than macro investors building a view," says W. Brad Bechtel, Global Head of FX at Jefferies LLC.

The selloff was significant, with the Pound to Dollar pair losing 1.10%, its biggest daily slump since Donald Trump won the U.S. election in November.

The Pound to Euro conversion fell as low as 1.2013 (-0.50%) before it pared the loss and recovered to 1.2057.

The Australian and New Zealand Dollars recorded gains of over 1.0% against the Pound, confirming this was a broad-based selloff against various currency classes.

Chapman explains the unusual moves are likely linked to low liquidity as market participants are still away from their desks.

"We are trading in a data vacuum. There is a good chance that these moves over the holiday period are unwound in the near term, and the labour market data is going to start to dominate next week," he explains.

Derek Halpenny, an analyst at MUFG Bank, says fears over growth in Europe remain a key focus for investors and this potentially weighed on Sterling and the Euro as 2025 got underway."The theme of energy price rises is again in focus and there has been another sharp rise in natural gas prices following the end of gas supplies running through Ukraine."

The cost of UK wholesale gas prices rose to a two-year high on Thursday, pointing to higher energy costs for businesses and households. The development is particularly difficult for businesses which will also face rising wage bills and taxes in the coming months.

"Increased fears over the economic impact of a renewed rise in natural gas prices saw the probability of a BoE rate cut in February increase modestly," says Halpenny.

The Pound is particularly sensitive to Bank of England interest rate expectations; the market sees between two and three rate cuts in 2025, but most analysts we follow think the real outcome will be four.

The market, therefore, must adjust to this view. As it does, UK bond yields and the Pound must fall.

But, again, it must be emphasised that the move in Pound exchange rates outstrips the fundamental nature of the developments.

"The view on GBP is more constructive than say for EUR, both from a fundamental macro position but also from a real rate differentials / monetary policy position. I feel like the GBP should be the next best currency after the USD this year, definitley in G10, but maybe outright as well, so it is interesting to see this little dip to start the year," says W. Brad Bechtel, Global Head of FX at Jefferies LLC.

One analyst points out that a fall in the Pound on the first day of trade in the new year has become a traditional phenomenon.

"Remarkably, this extends sterling's losing run on the first day of the trading year to seven years," says Shreyas Gopal, Strategist at Deutsche Bank.

Gopal points out that Pound Sterling has only managed three positive returns over twenty years of first-day trading.

Above: GBP/USD stays under pressure on Friday.

Given there is no clear narrative behind the declines, will the Pound snap back? Gopal warns against jumping into the dip.

"On a forward-looking basis, we find no strong pattern of first-day Cable losses either reversing or extending over the following week," he says.

But, Henry Allen, a fellow strategist of Gopal at Deutsche Bank, points out that "the first trading day has been a very poor guide to the rest of the year in recent times, so we shouldn’t extrapolate things too far."

Foreign exchange analysts we follow have the Pound outperforming most of its peers in 2025, helped by a relatively robust economy and a slow pace of interest rate cuts at the Bank of England.

In its year-ahead forecast docket, NatWest Markets says Pound Sterling looks like the "Carry King" of 2025.

Above: GBP/EUR has recovered about half of the loss recorded on January 02.

"Sterling’s 'carry' position against other G10 currency looks set to stay at 20y highs," says Paul Robson, Head of G10 FX Strategy at NatWest.

Carry refers to a strategy whereby investors borrow capital in places where interest rates are low to invest in financial assets where interest rates are higher, which typically offers a profit in a low volatility environment.

The subsequent flow of funds to where interest rates are higher creates a demand for the beneficiary currency.

The Pound was 2024's second-best performing currency as UK interest rates remain elevated compared to elsewhere, with the Bank of England saying it will cut interest rates with a sense of caution because inflation is expected to remain elevated.

"Sterling is set to maintain a favourable carry position through 2025 as the BoE stays a 'cautious cutter' while many other central banks remain 'enthusiastic easers'," says Robson.

If this view is correct, the Pound will look attractively valued following the January 02 selloff.