With a rising pound, when should you buy your summer holiday money?

Sterling has hit a two-year high against the euro, and surged against the dollar – which will mean cheaper breaks for British holidaymakers on the Spanish costas and on Florida fly-drives this summer. Happy days, and all that.

The pound hit $1.30 and €1.19 after publication of the UK’s latest official figures on inflation. It’s something of a line in the sand after the dark days of Liz Truss’s premiership in October 2022, when the pound sank almost to parity against the US dollar.

But what is behind the growing strength of sterling? Can it last? And when is the best moment to buy your holiday money?

Sterling’s story is primarily an interest rate story. One of the chief reasons for its rally against the euro is that the European Central Bank moved ahead of the Bank of England in cutting its deposit rate from a record high of 4 per cent to 3.75 per cent in June. Sweden, Switzerland and Canada have also cut. The fact that the UK’s rate-setting Monetary Policy Committee (MPC) has yet to follow suit makes it advantageous for investors to hold cash in sterling, where the returns are better.

The pound’s recent strength against the dollar is a more complex story, because the US Federal Reserve has also been sitting on its hands. However, the markets took note of last week’s US inflation data, which showed that the official rate fell to 3 per cent in June from 3.3 per cent in May. This was faster than economists had expected, raising hopes that the Fed will soon cut. Those hopes were further boosted by the central bank’s chair Jay Powell who expressed “confidence” that inflation was moving towards its targeted 2 per cent while speaking at the Economic Club in Washington.

In the UK inflation is already at 2 per cent, which is also the MPC’s target. However, the mood music here has been very different. Post-election, we’ve had speeches from external member Jonathan Haskell and the Bank’s chief economist Huw Pill, both of which poured varying amounts of cold water on hopes of an early move.

Moreover, the last set of inflation numbers were actually higher than economists had expected. The Bank of England has also repeatedly voiced concern about elevated underlying price pressures in the UK economy and questioned whether inflation can “sustainably” remain on target.

All this has affected the markets’ sentiment. Don’t underestimate the role that sentiment plays in all this. It is quite possible that both the UK and the US move rates downwards in September. But while sentiment is improving towards an early cut in the US, it is going in the opposite direction in the UK. Currency prices have responded accordingly, with sterling going up against the dollar.

The UK economy has also been performing a tad better than expected, which further boosts the pound. The Labour landslide, and the tough-talking on spending by chancellor Rachel Reeves, have bolstered confidence in a more stable and sensible political climate, adding yet more muscle to the currency.

The decision to give the Office for Budgetary Responsibility (OBR) a beefed-up role in overseeing budgets and policy was clearly political – it was a dig at Truss, and an attempt to keep her disastrous mini-Budget in the public consciousness while the country was voting.

The City has largely decided that it can trust Keir Starmer’s Labour government, which underpins sterling’s strength. But predicting markets is a risky business. Even the City’s expansively educated and richly rewarded corps of forecasters regularly get it wrong (and have, for the most part, been overly optimistic on when the Bank of England might cut rates). There is a reason that economics sometimes gets referred to as “the dismal science”.

Markets are apt to get ahead of themselves and then to correct. So right now is as close to good as it gets for those with an eye on buying currency.

The best way is to buy it in chunks, over time, better to smooth the effects of choppy markets. That said, even if the pound rises a bit more, it probably won’t rise by a lot from its current, elevated level. Now is as good a time as any to take the plunge.