British pound set for further declines

LONDON: In volatile currency markets, one trade stands out as an easy bet: selling the British pound.

In an economy grappling with a particularly unhealthy cocktail of slowing growth and surging inflation, the British currency has become the medium of choice to express a negative view.

Official data last week showed inflation reached a 40-year high of 9% in April — more than four times the Bank of England’s 2% target — while Britain’s worst cost of living crisis in three decades will not subside until late this year, according to a Reuters poll.

And though the BoE was the first among major central banks to raise interest rates in December, its predicted future path is far less steep than some of its global peers including the Fed.

While the British economy’s problems are broadly similar to what other policymakers are grappling with, a few unique factors additionally weigh on the pound.

One is the potential for a messy trade conflict with the European Union if Britain threatens to push ahead with a law to override parts of a post-Brexit trade deal for Northern Ireland.

Any protracted trade war would threaten to further widen the current account deficit and subsequently weaken the currency.

Then there is an increase in tax burdens, which followed massive temporary relief for struggling sectors during the pandemic and which has hit workers and employers already saddled with surging energy bills, adding to the drag on the economy.

“The chance of a UK recession is all but guaranteed as there are just too many headwinds facing the economy,” said Wouter Sturkenboom, an investment strategist at Northern Trust Asset Management.

Jane Foley, head of foreign-exchange strategy at Rabobank, says markets have slashed their UK rate hike expectations in recent weeks because recession risks have grown.

Using the spread between 3- and 1-year market rates, HSBC strategists predict UK interest rates will peak in June 2023, rising to 2.5%, and then rate cuts will follow.

“The consumer outlook has taken a big turn for the worse, as the real income squeeze bites hard and this will make it very difficult for the Bank of England to deliver anything close to what is priced into the forward rates market,” HSBC said.

HSBC now expects the pound, now trading at around $1.24, to end the year at $1.20, some 8% weaker than its earlier $1.30 forecast.