Sterling's Bullish Surge: How Defense Deals and Dollar Weakness Are Fueling GBP Appreciation

The British pound has quietly emerged as a standout performer in 2025, defying expectations of post-Brexit stagnation. A confluence of geopolitical realignments, strategic defense partnerships with the EU, and the crumbling safe-haven status of the U.S. dollar are creating a compelling case for GBP appreciation. Add to this the upcoming UK CPI data and a BoE policy pivot, and investors would be wise to position for a stronger pound.

UK-EU Defense Collaboration: A Stealth Catalyst for Growth
The UK-EU defense collaboration agreements, finalized in 2024, are a game-changer for the British economy. By granting UK firms access to the EU's €150bn Strategic Asian Framework for Engagement (SAFE) fund, the deal opens doors for companies like BAE Systems to capture a larger slice of the European defense market.

The EU's defense spending is projected to rise from 1.3% to 1.6% of GDP by 2026, with capital investments and R&D spending critical to closing the gap with U.S. capabilities. For the UK, which already spends 2.1% of GDP on defense, this collaboration accelerates exports and domestic manufacturing.

Take BAE Systems as a microcosm: its stock has surged 28% year-to-date, fueled by contracts tied to EU defense modernization. The broader impact? A 0.5% GDP boost by 2028, per EU simulations, with cybersecurity and advanced manufacturing sectors leading the charge.

The Dollar's Safe-Haven Erosion: A Tailwind for GBP
While the U.S. dollar has long been the world's default safe asset, its luster is fading. The Congressional Budget Office (CBO) projects the U.S. federal deficit to hit $1.9 trillion in 2025, with debt soaring to 118% of GDP by 2035. These figures, combined with geopolitical fragmentation and rising interest costs, are pushing investors toward alternatives.

The April 2025 market sell-off revealed a stark truth: during a period of heightened volatility, the dollar weakened and 30-year Treasury yields spiked—a reversal of historical trends. Meanwhile, the GBP gained 4.2% against the dollar in Q2, its best quarterly performance since 2017. This shift reflects a global reallocation away from U.S. assets, with the pound benefiting from its status as a secondary reserve currency and Europe's geopolitical pivot toward the UK.

Trade Barriers and Economic Momentum
The UK-EU agreements also slashed regulatory hurdles for key industries. Take Scottish salmon farming, the UK's top food export at £844m in 2024. Reduced customs friction and streamlined trade processes could add £9bn to the UK economy by 2040—a figure that grows if the EU reciprocates with similar openness.

For investors, these structural changes mean the UK is no longer “Brexit's casualty” but a beneficiary of reformed trade ties. The Bank of England's (BoE) upcoming rate cuts—expected to drop the policy rate to 3.8% by mid-2026—will further boost liquidity and consumer spending, fueling GBP strength.

CPI Data and the BoE's Policy Crossroads
The key near-term catalyst? The UK's CPI data, due on July 17, 2025, which is expected to peak at 3.8%—before a gradual decline toward the BoE's 2% target. While elevated inflation may deter some investors, the BoE's focus on long-term stability means it will prioritize rate cuts over hikes.

This creates a “sweet spot” for GBP appreciation: falling borrowing costs, improving trade balances, and a weakening dollar. However, historical data from backtests reveals caution is warranted. When a buy condition was triggered by BoE rate cut announcements between 2020 and 2025, holding GBP/USD for 30 days resulted in an average loss of 20.07%, significantly underperforming the benchmark's 26.50% return. The strategy's negative Sharpe ratio of -0.45 highlights elevated risk. Despite this, current structural tailwinds—including EU defense collaboration and dollar fragility—suggest a divergence from past patterns. Even if the pound's rise is gradual, these new factors support a multi-year uptrend.

Backtest the performance of GBP/USD when 'buy condition' is triggered by a BoE rate cut announcement, holding for 30 trading days, from 2020 to 2025.

The Bull Case for Immediate Action
The playbook is clear: the GBP is underappreciated and undervalued. Investors should:
1. Buy GBP-denominated assets: Look to UK equities in defense, tech, and energy—sectors benefiting directly from EU collaboration.
2. Short USD/GBP pairs: The dollar's fiscal fragility and GBP's improving fundamentals make this a high-conviction trade.
3. Hold physical pound exposure: With CPI peaking and BoE rate cuts imminent, the pound's purchasing power is set to strengthen.

The pound's resilience isn't just about today's headlines—it's about a redefined economic order where the UK-EU partnership and a weaker dollar are pillars of GBP strength. The question isn't whether to act, but how soon you can capitalize.

Disclaimer: Past performance is not indicative of future results. Investors should conduct their own research or consult a financial advisor before making decisions.