Pound still suffers from the UK’s weak economic outlook - Dailyforextrading

Pound still suffers from the UK’s weak economic outlook - Dailyforextrading

The UK’s weak growth outlook has been weighing on sterling all year. This has meant that it has not seen much benefit from the Bank of England starting its rate rise cycle sooner than many of its G10 peers. 


The pound has dropped around 10 per cent against the dollar and a little under 1 per cent against the euro.

Economics textbooks indicate that higher interest rates are supportive of currencies.

That said, there has been clear evidence around the world recently that the tone of central bank policy statements has been having a key directional influence on currency markets, almost irrespective of interest rate announcements. What matters is the commentary on the outlook.

And that tone from the UK has been pretty bleak. In May, the pound tumbled following the BoE’s 0.25 percentage point rate rise announcement, primarily owing to the market’s shock at the central bank’s coincident downward revision for UK growth.

And in an astoundingly candid policy statement on August 4, BoE governor Andrew Bailey warned that the UK economy was set to drop into a 15-month recession in the fourth quarter of this year. The pound lurched lower against the euro as a result, although it ended the day a little higher.

This grim outlook is being accompanied by a warning by the BoE’s Monetary Policy Committee that it will continue to raise rates in order to curtail inflation that is now expected to peak at about 13 per cent.

At Rabobank, we expect 1 percentage point of additional rate increases: 0.50 points in September, 0.25 in November and 0.25 in December.

There is a high likelihood this tightening will be reversed from the second half of 2023 onwards to boost demand if supply-side issues that are lifting inflation are resolved. But still, current warnings on UK growth come at a time when investors are assessing the shape of post-Brexit Britain. 

In a report published in June 2021, the BoE concluded that both Covid and Brexit have had a large impact on business investment.

It is estimated that the UK’s decision to leave the EU increased uncertainty and lowered the level of investment by almost 25 per cent in 2020-21, with the effects having built up gradually since the 2016 Brexit referendum.

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In a speech last month, outgoing MPC member Michael Saunders stated that Brexit and Covid have reduced growth potential because of lower labour supply, weak investment, and, owing to leaving the EU specifically, reduced trade openness. 

The fact that the pound has never been able to recover to the levels traded against the euro before the Brexit referendum corresponds to the weakness of investment in this period. 

The UK maintains a current account deficit with an imbalance of imports over exports. This is not a preordained indicator of currency weakness, but it does expose a currency to downside pressure under certain circumstances.

Since the current account deficit indicates that the UK is a net borrower from the rest of the world, the pound is likely to adjust lower if the country’s fundamental backdrop is not attractive to overseas savers. Investors would like clear leadership defined by fiscal prudence and by policies designed to improve productivity and long-term growth potential.

Uncertainty is a powerful disincentive for many investors and it would appear that the UK government has not done enough to convince overseas investors of the benefits of Brexit.

Both remaining candidates for the Conservative party leadership worked closely with outgoing prime minister Boris Johnson and there are no guarantees that either would significantly alter economic uncertainties and improve the overall environment for investors. 

The new PM could also struggle to gain broad-based support in a country that is on the cusp of recession. Shortages of labor in the UK combined with the cost of living spike have already stirred strike action and, with a winter energy price crisis looming, further pockets of unrest are possible.

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This could lead to a choppy period for politics ahead of the 2024 general election — which would be another headwind for the pound.


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