Is the pound doomed?

In comparison, interest rate expectations in Great Britain have risen sharply as a result of the measures taken by the new British government.


© Capstone

Chancellor of the Exchequer Kwasi Kwartengs’ “budget plan” was not well received by the financial markets. “The cap on energy prices likely spared the UK a short-term recession, but the doubling of tax cuts has further increased debt,” writes Steven Bell, chief EMEA economist at Columbia Threadneedle Investments, in his weekly market commentary. The level of debt can only be speculated on, as Kwarteng prevented the Office for Budget Responsibility (OBR) from correctly calculating the numbers.

Sterling is at an all-time low and interest rates are expected to rise above 6%. Government bond yields rose. Steven Bell sees a similar pattern globally: “Central banks are raising rates faster than markets expect and bond yields are rising. However, interest rate expectations in the UK have skyrocketed in comparison due to the actions of the new UK government.”

Although capping energy prices this winter may have averted a recession, the UK economy remains vulnerable.

According to him, the pound sterling is particularly vulnerable due to the huge current account deficit and the level of external debt. This is not the only reason why the deficit reached a record level in the first three months of the year. Admittedly, consensus expects Friday’s new numbers to improve. “But the big picture looks very difficult,” Bell said. The willingness of foreign investors to bail out the UK impasse would depend heavily on global risk appetite. If stock prices rise, the pound sterling would tend to appreciate. “Last week shares were very weak, bad timing for Kwarteng tax announcement.”

Several members of the Monetary Policy Committee (MPC) will speak this week and will certainly take a ‘hawkish’ stance. Government statements have tried to blame the pound’s fall on the MPC’s decision to raise interest rates by “just 0.5%”. Bell finds this a little strange, given that the Bank of England is independent, but the government appoints its members, and while it cannot legally fire Governor Andrew Bailey, it would almost certainly resign if the Chessboard Chancellor so wished. Many expected Bailey to step down early next year. Bell hopes he doesn’t. He doesn’t rule out skepticism from the rating agencies. “However, the governor is only one member of the MPC, and many other members of the committee would like to oppose the government and aggressively raise interest rates,” writes Bell. Bell advises against an emergency rate hike meeting before the next November 3 meeting. “It might look like a sign of panic.” Instead, Bell recommends raising interest rates to 5% over the next few months to attract funds from abroad. Still, the British economy would need some luck to avoid a financial crisis.

The pound has recovered somewhat in the short term but could break parity against the US dollar in the coming weeks, according to analyst Columbia Threadneedle. According to Bell, “higher interest rates are needed to offset the increased risk associated with the new Chancellor’s actions. Although capping energy prices this winter may have averted a recession, the UK economy remains vulnerable.”

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