Understanding the trends so you can manage the risks
Foreign exchange rates are in constant flux, influenced by various factors, and exchange rate volatility can significantly impact the profitability of any company that trades in multiple currencies. This article provides an accessible guide to the foreign exchange forecasts for the British Pound (GBP), US Dollar (USD), and Euro (EUR), examining their current state, recent changes and predictions for the future.
It also summarizes some strategies for managing the risk which can be caused by day-to-day transactions and large one-off purchases (such as machinery).
The Interplay of Interest Rates and Exchange Rates
Central banks set interest rates, which influence the returns from holding a particular currency or the cost of borrowing it. Higher interest rates can attract foreign capital seeking better returns, increasing demand for the domestic currency and strengthening it. Conversely, lower interest rates can make a currency less attractive, leading to depreciation.
GBP Forecast
As of February 24, 2025, the GBP is trading at 1.2640 USD. Over the past year, the pound has experienced a slight decrease in value against the dollar, down by -0.33%. However, year-to-date, it has shown a 1.04% rise. The GBP has reached a 2-month high this week, surpassing 1.26 against the USD following strong inflation data. This recent peak comes after the GBP/EUR exchange rate reached a 3.5-year high in December 2024, highlighting the recent strength of the pound.
Predictions for the future vary, creating uncertainty for businesses. Some analysts predict a strengthening of the pound, potentially reaching 1.471 USD in 2025. Others anticipate a gradual decline, with the GBP/USD exchange rate falling to 1.181 by 2029. ING forecasts a GBP/USD rate of 1.23 in one month. This divergence in forecasts highlights the need for businesses to closely monitor economic and political developments in the UK. The Bank of England potentially cutting interest rates sooner than the Fed due to the global trend of central banks considering rate cuts could further contribute to a decline in the GBP. However, Goldman Sachs remains optimistic about the fundamentals of the pound, suggesting a potential for it to outperform.
Several factors can influence the GBP exchange rate, including monetary policy, economic performance, global economic trends, and political stability.
Monetary policy: The Bank of England's decisions on interest rates play a crucial role in the pound's value. Higher interest rates generally attract foreign investors, strengthening the GBP. For example, if the Bank of England raises interest rates while other central banks keep rates steady or lower them, this can make the UK a more attractive destination for foreign capital, increasing demand for GBP and potentially leading to appreciation.
Economic performance: The UK's economic health, including growth, inflation, and employment, significantly impacts the value of the pound. Positive economic indicators, such as strong GDP growth or low unemployment, can boost confidence in the UK economy, attracting foreign investment and supporting a stronger currency.
Global economic trends: International events, like changes in global trade policies or economic crises, can influence the pound's value. For example, increased global uncertainty or a slowdown in global economic growth could lead to a decline in demand for GBP, as investors seek safer assets.
Political stability: Political uncertainty, such as that surrounding Brexit, can create volatility in the GBP exchange rate. Political events that raise concerns about the UK's economic or political stability can negatively impact investor confidence and lead to depreciation.
The primary risk associated with buying and holding GBP is the potential for its value to fluctuate. Economic or political instability can lead to depreciation, resulting in losses for those holding the currency.
USD Forecast
The USD has shown an upward trend, surging by 7% in 2024. The DXY index, which measures the dollar's value against a basket of currencies, remains near all-time highs. This strength is attributed to several factors, including the robust growth of the US economy relative to other developed markets, increasing divergence in global growth, and greater disparity in central bank policies worldwide. Trump's return has spurred a dollar rally, driven by renewed optimism about the US economy and the potential impact of his proposed policies.
The USD is expected to stabilize or even appreciate further in 2025, based on the continued robust growth of the US economy, the Fed's cautious approach to interest rate cuts, and potential policy changes under the new administration. However, some analysts anticipate a downturn in the dollar's value in the longer term due to factors such as the US's persistent trade balance deficit.
Several factors can affect the USD exchange rate, including economic growth, monetary policy, inflation, government debt, and political stability.
Economic growth: The relative strength of the US economy compared to other major economies is a significant factor. Stronger growth attracts foreign investment, leading to a stronger USD.
Monetary policy: The Fed's decisions on interest rates play a crucial role, as higher interest rates generally attract foreign capital and cause the exchange rate to rise.
Inflation: Higher inflation typically leads to depreciation in a currency's value. It is important to note that both the UK and the US have seen an upward trend in inflation since September 2024.
Government debt: Countries with large public deficits and debts are less attractive to foreign investors, potentially leading to currency depreciation.
Political stability: Political uncertainty can affect investor confidence and influence the USD exchange rate.
Holding USD carries the risk of potential depreciation if the factors supporting its strength weaken. A significant devaluation of the dollar can lead to losses.
EUR Forecast
The EUR has experienced a decline against the USD in recent months, falling from highs of 1.12 in mid-2024 to 1.04 in February 2025. This depreciation is attributed to the economic resilience of the US, the re-election of Trump, and the growing weakness of the eurozone. Concerns over economic growth and soaring energy costs in the UK have also historically contributed to euro strength against the pound.
The euro is expected to remain under pressure in the short to medium term, with the possibility of reaching parity with the USD. This is due to the interest rate spread between the Eurozone and the US, which currently favors the dollar. The ECB's potential interest rate cuts in September and December could add to this pressure. However, a gradual appreciation is anticipated in 2026, supported by an adjustment to monetary policies on both sides of the Atlantic.
The European Central Bank's (ECB) decisions on interest rates significantly influence the EUR. Lower interest rates can weaken the Euro. The ECB appears committed to a more aggressive easing cycle to counter the region's economic weakness, which could prolong depreciation. Factors such as the intensification of Trump's protectionist policies or a further weakening of growth in the Eurozone could contribute to depreciation.
Managing Foreign Exchange Risk
Businesses can employ several strategies to manage foreign exchange risk:
Setting up bank accounts for the foreign currencies - Foreign currencies transactions are paid into these and you choose to exchange them when the rates are favorable. These are only worth setting up where you have a substantial value of volume of foreign currency transactions.
Forwards Contracts – Agreeing to buy or sell an amount of currency at a future date. There is a cost to setting this up, but it is ideal when making one-off purchases, for example for machinery.
Options – Paying for the right to buy or sell a currency amount at a future date, The option does not need to be exercised. There is a cost to buying these but again is useful for large purchases.
Negotiating favorable contract terms: Including currency clauses in contracts can help manage currency risk by specifying payment in a stable currency or outlining how parties will share potential losses from exchange rate changes.
Conclusion
There are tools available to businesses to help them manage their foreign exchange risks and costs. Understanding how foreign exchange markets works is vital for forecasting them but unless you have a large upcoming transaction or transact at volume in a foreign currency, you may decide that locking in a price today is all that you want to do.
