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Market Insights

GBP: Things can only get better?

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We’ve been bombarded with negative headlines about Britain of late. The energy crisis, Brexit uncertainty, no functioning government (although plenty of Brits would argue that’s nothing new), and UK bond markets have sold off drastically, increasing borrowing costs amid the general pessimism.

All of which has weighed on the Greatest of British Pounds. The GBPUSD pair has seen the most pronounced moves as the dollar continues its mission to defeat all pretenders to the throne:

GBPUSD

The weekly chart really puts the GBP weakness and USD strength this year in perspective. At the start of the year, the pair traded just below 1.3750. It’s now trading with a 1.15 handle, over 2200 pips lower. So far in 2022, the pound has devalued by an average of 275 pips per month against the dominant US dollar. It’s far from alone in struggling against the USD, but the magnitude is still noteworthy.

Light at the end of the tunnel?

“If you’re going through hell, keep going” - Winston Churchill

We covered a lot of the issues facing the UK last month. On the 6th of September, the UK should have a new Prime Minister. It will probably be Liz Truss.

An economic stimulus and/or support package is expected soon after. Brits are eagerly awaiting the measures to bring energy bills down and help with the ‘cost of living crisis’.

However, the package could be a double-edged sword. Some of the measures discussed include tax cuts, and this has stoked fears that the UK government could be forced to borrow more and potentially fan the flames of inflation even further.

Interest rate markets are now pricing in a peak interest rate of 4.25% next year, with the measures potentially forcing the Bank of England to hike rates to higher levels to counteract any renewed inflation pressure.

Even if the support measures don’t prove to be inflationary, there’s a chance that the Bank of England will be forced to hike anyway. The latest Citi/YouGov Poll showed that UK public inflation expectations for 5-10yrs ahead jumped to 4.8% from 3.8%, with the 1yr ahead expectation rising to 6.8% from 6.1%.

This is an indication of inflation becoming entrenched in the economy, and such a large jump in the 5-10 year horizon will surely have caught the eye of the central bank. Signs of ‘de-anchoring’ of inflation expectations over the longer-term are not welcome news for rate-setters.

Essentially, if people expect inflation to remain high for a longer time, then it can influence how they behave, how they spend and how prices are negotiated in the economy, further fuelling inflationary pressures. The price of labour is chief among these concerns. If you ever meet a central banker, whisper “wage-price spiral” in their ear and watch them shudder. It’s rumoured to be an instinctive reaction.

As for the pound, Kit Juckes, chief foreign exchange strategist at Société Générale summarises the overall picture well:

“Sterling’s support is waning. The UK economy is in recession, the balance of payments is catastrophic and more or faster rate hikes won’t do much to restore confidence”

However, this story may be getting stale. It’s been the same for some time and now faces off against UK bonds that are more fairly-priced relative to peers, a GBP almost as weak as it was at the depths of the Covid shock in March 2020, the prospect of decisive action to restore stability to energy markets and new leadership. Maybe ‘Trussonomics’ won’t be as radical as feared either.

Overall, there’s still plenty to be concerned about in the UK economy, but perhaps it’s not quite the one-way bet it has been for most of the year so far.

Not investment advice. Past performance does not guarantee or predict future performance.

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