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Pound Sterling has rallied to one-week highs against the Dollar and is testing the top of a key range against the Euro, aided by positive investor sentiment.

Global risk sentiment is positive, with the S&P 500 stock index hitting a fresh record on Monday as investors look forward to the year in which interest rates at the major central banks begin to fall.

The Pound tends to advance against the Euro and Dollar in such environments, allowing it to shake off the weakness that followed last Friday's surprisingly soft retail sales data release and extend its 2024 rally.

"The pound is a unique currency that tends to do especially well in an environment of moderating rate volatility and buoyant equity prices," says Kamakshya Trivedi, a strategist at Goldman Sachs.

The S&P 500 reached a new all-time high of 4868 on Monday, while the Pound to Dollar exchange rate extended its rally to 1.2744 by the time of writing on Tuesday.

"It looked more like investors were buying into the rally as they realised they had been missing out on the strong rally lately as growth and inflation outlooks have improved more than expected," says Magnus Poulsen, an analyst at Danske Bank.

The Pound to Euro exchange rate has risen to 1.1683 where it meets medium-term resistance (it has been unable to close above 1.1680 since December 2023).

Above: Pound-Euro at daily intervals. Track GBP with your own custom rate alerts. Set Up Here.

Recent gains mean the Pound has reclaimed the title of best-performing G10 currency of 2024 amidst supportive global equity markets and a recalibration in market expectations for the amount of interest rate cuts likely from the Bank of England in 2024.

Heading into the new year, markets had anticipated a cut as early as March, but a push-back in Federal Reserve rate expectations and robust UK data means markets are now fully priced for a June hike.

This was reinforced by last week's above-consensus inflation print that revealed year-on-year CPI inflation had returned to 4.0%.

Christopher Wong, an analyst at OCBC Bank, says he sees room for the Pound to recover on a combination of mild positives:

UK demand growth is proving resilient (owing to strong labour market, falling energy prices)consumer confidence reboundinglabour market remaining tight alongside higher real wageshigher participationBank of England potentially keeping rates elevated for awhile longer (yield allure)while better finances allow for some degree of stimulus ahead of elections

Above: GBP has advanced against all G10 peers in 2024.

Wong says the Bank of England may have room to keep rates high for a little longer than the Fed and ECB.

"We still hold to a mild upward trajectory for GBP as BoE is likely to keep rates restrictive for a little longer as inflationary pressures remain, and potential BoE-Fed policy divergence may be supportive of GBP," says Wong.

A risk to the outlook is an earlier-than-expected BoE "pivot" whereby the Bank signals it will soon cut interest rates.

Another risk is the global equity market backdrop deteriorating, which would see some of the Pound's recent 'risk on' gains reversed.

As Wall Street’s S&P 500 reached its first record close in over two years on Friday, the CEO of one of the world’s largest independent financial advisory and asset management organisations is issuing fresh warnings to investors.

"With the S&P 500 topping 4,800 for the first time in its 66-year history, it’s all-too-easy for investors to become overly confident and complacent," says Nigel Green, CEO of deVere Group.

"Markets are getting ahead of themselves. Much of the frenzy is being driven by hype that the Federal Reserve is about to start cutting rates after the most aggressive tightening agenda in generations," he adds.

Green warns that although inflation is certainly down from the multi-decade highs, it remains sticky.

"Is there really enough evidence for the Fed to pivot? The jury’s out."