Investors are betting that the pound will fall even further after a hard start in 2022, as a “disastrous” combination of high inflation and slowing growth has clouded the UK’s economic outlook.
Betting that the pound sterling will fall is nearing a three-year high, according to data from the Commodity Futures Trading Commission, which tracks the position of speculative investors in futures contracts, an indicator of sentiment in the $ 6.6 trillion a day foreign exchange market.
Although Boris Johnson survived a parliamentary vote of confidence this week, which could have avoided a period of political turmoil, markets are focused on the gloomy economic environment, analysts say, which means it is unlikely that the victory of the British Prime Minister causes a change of direction for the currency.
The pound moved back and forth around Monday’s vote, but on Thursday it traded near where it was against the U.S. dollar a week ago at $ 1,254. This year it has dropped 7% against the dollar.
Currency traders say the implications of Johnson’s victory were overshadowed by uncertainty over who could have replaced him. At the same time, the political turnaround remains largely a secondary spectacle for a foreign exchange market focused on the potential for a UK recession later this year, which could halt the Bank of England’s efforts to control inflation by raising interest rates.
“The market is very bearish with the pound sterling,” said Sam Lynton-Brown, head of developed market strategy at BNP Paribas. “Domestic political uncertainty has not been a major driver of the currency. So even if you are relieved, you should not expect the pound to recover. We still think it could be further weakened. “
The BoE has raised interest rates four times since tightening monetary policy in December, well ahead of counterparts such as the US Federal Reserve and the European Central Bank. However, the pound has lost ground to the euro and the dollar this year as investors begin to wonder how long they can continue to raise borrowing costs with consumers facing a sharp crisis. of the cost of living.
“When we arrive in the UK in the autumn, the impact on household income from inflation, but also from higher rates, will be so marked that the window of opportunity for the BoE to raise rates will close.” said Jane Foley, director. of currency strategy in Rabobank.
The issue of how to control inflation without slowing growth is not unique to the BoE. But some investors are concerned that the UK dilemma is more acute than other major developed economies are facing. The OECD predicted on Wednesday that the UK economy would stall next year, with only the affected sanctions on Russia worsening among G20 nations.
“Even if inflation falls again in other major economies, we are likely to have a more persistent problem in the UK,” said Mark Dowding, chief investment officer of BlueBay Asset Management. “An inflationary environment will be quite disastrous for all UK assets and for the pound,” he said, describing the combination of rising prices and slowing growth. “We could end up in a scenario where the pound is on its way to parity with the euro and the dollar.”
According to Dowding, recent comments by Governor Andrew Bailey that the BoE is “helpless” to fight inflation have not helped.
“Even if they think that, they shouldn’t tell everyone. It will only further increase inflation expectations,” he said.
Lynton-Brown said stubbornly high inflation would affect foreign demand for the UK’s public debt, which is trading at some of the lowest inflation-adjusted yields in the world. If there are no persistent entries into gilts to fund the UK current account deficit, the exchange rate should be adjusted downwards, he said.
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For some analysts, the sadness surrounding the pound sterling could be a source of short-term resilience.
According to Nomura strategist Jordan Rochester, a global rise in the stock markets could increase the pound, which tends to move alongside riskier assets as bearish investors pull out of their short positions.
Investors could also accept a renewed threat to Johnson’s position, betting that his successor would be less likely to increase trade tensions with the EU by abandoning the post-Brexit trade deal for Northern Ireland, he said.
“The market has become so negative for policy in the UK that it tends to lean towards the positive if there is any promise of change,” Rochester said. “But we have to be careful because we don’t know what a change of leadership means for politics, for spending or for reform, because we don’t know who comes next.”
“The next Conservative leader may not be running to break the Northern Ireland protocol, but you could also get an even tougher Brexit,” he added.