Will the Dollar Get Stronger Against the Pound?

The foreign exchange market has witnessed heightened volatility between the US dollar (USD) and the British pound (GBP) in recent quarters, prompting investors and businesses to closely monitor the currency pair’s trajectory. As of Q1 2025, the GBP/USD exchange rate hovers around 1.25, reflecting a 3% decline from its peak in late 2024. This trend raises a critical question: will the dollar continue to strengthen against the pound?This analysis examines multiple determinants, including macroeconomic indicators, central bank policies, geopolitical risks, and market sentiment.

While short-term fluctuations can be unpredictable, a structured evaluation of underlying factors provides insights into potential long-term trends. For instance, the Federal Reserve’s (Fed) monetary policy divergence from the Bank of England (BoE) could significantly impact currency valuations. Additionally, post-Brexit economic adjustments in the UK and US fiscal stimulus dynamics further complicate the outlook. To fully grasp these dynamics, it’s essential to consider historical parallels; during the 2016 Brexit referendum, the pound depreciated by 15% within a month, highlighting the sensitivity of GBP to geopolitical events.

Macroeconomic Fundamentals: Growth and Inflation Disparities

US Economic Resilience

The US economy has demonstrated robust growth in 2024, with a 3.8% GDP expansion driven by consumer spending and business investment. This momentum is supported by several factors:

Low unemployment:  The jobless rate stabilized at 3.4%, below pre-pandemic levels, fueling wage growth. Average hourly earnings increased by 4.2% year-on-year, boosting disposable income and driving retail sales up by 6.5%.

Inflation normalization:  Headline inflation moderated to 2.5% in Q4 2024, aligning with the Fed’s target. Core inflation, excluding volatile food and energy prices, also decelerated steadily, thanks to improved supply chain efficiency post-pandemic. For example, semiconductor shortages, which previously inflated electronics prices, reduced by 30% compared to 2023 levels.

Tech sector dominance:  Sectors like AI and renewable energy attracted record venture capital, boosting productivity. In 2024, AI startups alone raised over $80 billion, leading to the development of innovative applications that enhanced operational efficiency across industries. The renewable energy sector saw a 25% increase in installed capacity, reducing reliance on fossil fuels and bolstering the green economy.

UK Economic Headwinds

In contrast, the UK faces structural challenges:

Brexit aftermath:  Trade barriers with the EU led to a 5% decline in manufacturing exports in 2024. Case in point, automotive exports, a key UK industry, dropped by 8% due to new customs checks and rules of origin requirements. Small and medium-sized enterprises (SMEs) were disproportionately affected, with 30% reporting reduced orders from EU clients.

Stagflation risks:  Inflation remains elevated at 4.2%, while GDP growth stagnated at 1.2%. The cost of living crisis intensified as energy bills surged by 40% year-on-year, squeezing household budgets and dampening consumer confidence. Consumer confidence index in 2024 hit a decade-low, falling 18 points compared to 2020 levels.

Labor shortages:  Sectors like healthcare and hospitality report 1.2 million unfilled positions, hampering output. In the hospitality industry, this translated to a 12% reduction in service capacity during peak tourist seasons, leading to lost revenue opportunities.

Central Bank Policies: Diverging Paths

Fed’s Hawkish vs. BoE’s Caution

The Fed adopted a hawkish stance in 2024, raising interest rates four times to 5.25%. Chairman Jerome Powell signaled further tightening if inflation rebounds. This policy was aimed at preventing overheating in the economy and maintaining price stability. By contrast, the BoE paused rate hikes at 4.75% in Q4 2024 due to economic uncertainty. The UK’s fragile economic recovery and persistent inflationary pressures from supply chain disruptions forced the BoE to adopt a more cautious approach.

Interest Rate Differentials

Higher US rates attract foreign capital seeking yield, increasing dollar demand. The current 50-basis-point spread between US and UK rates incentivizes carry trades—borrowing pounds to invest in dollar-denominated assets. Hedge funds and institutional investors have increasingly utilized this strategy; data from Bloomberg shows that carry trade volumes in GBP/USD increased by 25% in 2024, exacerbating downward pressure on the pound.

Quantitative Tightening

The Fed also reduced its balance sheet by $95 billion monthly, withdrawing liquidity from the market. This quantitative tightening (QT) policy reduces the money supply, effectively strengthening the dollar. Meanwhile, the BoE maintained its asset purchase program, further widening policy divergence. The BoE’s continued bond purchases aimed to stimulate lending and economic growth but had the side effect of keeping the pound relatively weaker compared to the dollar.

Geopolitical Risks: Uncertainty Premiums

US Political Stability

Despite polarized elections, the US maintains institutional predictability. The new administration’s commitment to fiscal responsibility eases concerns over debt sustainability. The passage of the Fiscal Responsibility Act in 2024, which capped government spending and outlined a path to reduce the deficit, reassured international investors. This stability contrasts with periods of policy gridlock in the past, where government shutdowns or debt ceiling crises temporarily weakened the dollar.

UK Political Turmoil

Internal disputes over devolution (e.g., Scottish independence polls) and EU trade renegotiations introduce volatility. Each 1% increase in the UK’s political risk index historically correlates with a 0.5% GBP depreciation. In recent Scottish independence referendums, opinion polls showing a narrowing gap between “Yes” and “No” votes led to short-term pound sell-offs. Additionally, ongoing negotiations over the Northern Ireland Protocol have created trade uncertainties, further weighing on the pound.

Global Shocks

External events like oil price spikes or Chinese economic slowdowns disproportionately affect the UK due to its higher import dependency. The UK imports 80% of its oil requirements, making it vulnerable to price fluctuations. When Brent crude prices surged by 20% in Q2 2024, the UK’s trade deficit widened by £5 billion. The US, with greater energy self-sufficiency, is better insulated. Thanks to the shale revolution, the US became a net exporter of oil in 2023, reducing its exposure to global energy price shocks.

Market Sentiment and Technical Analysis

Speculative Positioning

CFTC data shows hedge funds hold a net long position of $12 billion in USD against GBP, reflecting bullish sentiment. Sentiment surveys also indicate 68% of traders expect further dollar strength. This consensus view influences short-term trading behavior; as more traders enter long dollar positions, it creates a self-fulfilling prophecy driving the exchange rate higher. However, sudden shifts in sentiment, such as unexpected economic data releases, can quickly reverse these positions.

Technical Indicators

Moving Averages:  The 50-day moving average of GBP/USD recently crossed below the 200-day average, signaling a bearish trend. This “death cross” pattern is widely followed by technical analysts as a sell signal. Historical data shows that after similar crossovers, the GBP/USD pair declined by an average of 4% over the subsequent three months.

Volatility Index:  The Cboe FX Volatility Index for GBP/USD increased to 14.5, indicating higher price swings favoring the dollar. Higher volatility often leads to increased demand for the dollar as a safe haven, as investors seek stability during uncertain times.

Dollar as a Safe Haven

During market stress, investors flock to the dollar. With rising geopolitical tensions in Eastern Europe, the USD has appreciated 2.3% against major currencies in 2025. In times of crisis, the dollar’s status as the world’s reserve currency makes it a preferred asset for capital preservation. For example, during the 2008 financial crisis, the dollar strengthened by 20% against a basket of major currencies as investors fled riskier assets.

Commodity Dependence

The UK’s status as a net energy importer exposes it to oil price fluctuations. A 10% increase in Brent crude prices reduces UK GDP by 0.3%, while boosting the dollar via increased demand for oil payments. Since oil transactions are predominantly denominated in dollars, higher oil prices increase the global demand for dollars. Conversely, the US benefits from its domestic oil production; an increase in oil prices can stimulate the US energy sector, driving economic growth and strengthening the dollar.