The British Pound has been in significant turmoil. The price of the GBP/USD was trading around 1.14 on September 14, and it fell all the way to 1.034 on September 26, triggering considerable speculation that the currency would reach parity. Ever since the pound has recovered its losses, the big question has been is if the path of the least resistance has changed its direction to the upside. I believe that there is more weakness to come for the British Pound, and here are some of the reasons.
Government's U-turn
The UK's Chancellor of Exchequer announced a mini-budget last month, laying out the plans under the leadership of the new Prime Minister, Liz Truss. The mini-budget was not only controversial but also triggered concerns from the IMF about the UK's debt. The Chancellor and the Prime Minister tried their best to stand behind their controversial plan (specifically, reducing the taxes for the rich) but had no option but to give in as the UK's gilt market went into turmoil, flaming a further sell-off for the sterling.
Although the Chancellor has made a partial U-turn on his policy and Truss has addressed the Conservative Party Conference to assure that she has what it takes to run the country, the damage has already been done. The loss of credibility and another major shake-up in the UK's leadership is under question, and this poses another threat to sterling. The sterling fell 2.1 % against the dollar after her speech.
Economic data
Economic data in the UK is poor and weak. For instance, on Monday, British manufacturing production fell for the third month in a row in September, while orders decreased for the fourth month in a row. Both of these declines were caused by a decrease in overseas demand. The S&P Global manufacturing Purchasing Managers' Index (PMI) increased to 48.4 from its 27-month low of 47.3 in August. However, the index continued to stay below the 50-level that distinguishes expansion from contraction, and it was a touch lower than the original 'flash' estimate of 48.5.
The public net borrowing number missed estimates by a long shot; the actual number came in at 11.1B, while the forecast was for 8.2B. Similarly, the GDP data released in September confirmed that the economic growth is trending downward. The retail sales data further provided an echo of the above as retail sales m/m fell to -1.6% against the estimate of -0.5%. Perhaps the only good news was the CPI y/y number which printed the reading of 9.9%, just a touch shy of a double-digit number.
Why Economic Conditions Will Become Worse
The reality is that in the month of October, we are likely to see economic conditions become even weaker. There are two major reasons for this.
Firstly, energy bills have increased 80% in comparison to the previous month. It is true that the government has brought an energy cap £2500 for each house for a year, but this is still substantially higher for households. To put this into perspective, households in the UK will be paying more than double, if not more, for their energy bill as compared to the last bill. This extra burden on them is going to erode their disposable income further and is highly likely to translate into weak consumer spending.
Secondly, the UK mortgage cost for households in the UK has touched its highest level since 2008. The average two-year fixed rate mortgage on a home has jumped to 6%, and the five-year fixed deals are only a touch shy of 6%. This means that the average monthly cost of a two-year fixed-rate mortgage has increased to £1325, nearly double its previous payment. This is the direct result of the Bank of England's monetary policy.
The Bank of England has been increasing the interest rates aggressively to control inflation, and the anticipation is that the Bank of England will increase the interest rate by nearly a full percentage point during its next meeting in November. The Bank of England has very much made its position clear that it is willing to accept recession, but higher inflation is something that the bank cannot take.
During the meltdown of the British Pound, when it made a low of 1.0341 against the dollar, speculation was growing that the bank may have to intervene before their meeting to stabilize the currency by hiking interest rates. The Bank of England did intervene, but it didn't announce an increase in the interest rate but the unlimited purchase of UK gilts for a limited period. Their move has stemmed losses for the sterling now, but it isn't over yet. In my opinion, another 75-basis point interest rate is strongly on the cards, and that is only going to make life even more difficult for UK households.
To conclude, the current rally in the British Pound seems to be nothing more than a dead-cat bounce. With the government's U-turn on its mini-budget and the Bank of England's intervention, there has been some stability for the sterling. But economic fundamentals have only shifted for the worse, and this keeps the door open for the pound to revisit its recent lows of 1.034 or even reach parity with the U.S. dollar.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Naeem Aslam
I am a former Hedge Fund Trader with over 15 years of experience in investment banking. During my early career, I was awarded a national award (Young Irish Broker) in 2010. Over the years, I have worked with Bank of America in equity trading and with Bank of New York in hedge fund trading. I specialize in Blockchain technologies (cryptocurrencies and digital assets) and Sustainable Investments. In my career thus far, I have also extensively covered Equities, Commodities and Forex.
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