After a shaky 2022, the pound is in for another tough year
[LONDON] How the British pound performs in the new year, after enduring a poor showing in 2022, will largely hinge on renewed international investor confidence in the UK.
In the last couple of months, Prime Minister Rishi Sunak and Chancellor of the Exchequer Jeremy Hunt have steadied the economic and financial ship since former premier Liz Truss’ disastrous October mini-Budget precipitated a financial crisis.
From its October low of 1.03 against the US dollar, the pound has rallied by about 17 per cent to 1.21 as at Tuesday (Dec 27) and has recovered against major currencies such as the euro, yen, Swiss franc and the Singapore dollar.
But confidence in the pound and the UK economy as a whole remains fragile, even though some bargain-hunters cite that yields on 10-year gilts (UK sovereign bonds) are at 3.6 per cent and offer relatively good value. They are currently only slightly lower than 10-year US Treasury bond yields of 3.7 per cent.
Some foreign asset managers, however, are wary of buying UK assets for the time being and are limiting their holdings of the pound and British debt. Vincent Mortier, the chief investment officer of Europe’s largest fund manager Amundi, was quoted in a Dec 16 Reuters report as saying that “the risks are too high compared to the rewards”.
What’s clear is that the government needs to restore confidence in London’s financial sector. Both foreign and local investors were disturbed when the Bank of England (BOE) was forced to buy £19 billion (S$31 billion) of long-dated and index-linked gilts in early October in a bid to restore stability in the financial market. The central bank is now busy trying to sell these gilts to investors.
In recent weeks, the rally in global stock markets has helped the pound’s prospects. Historically, foreign exchange analysts have regarded the pound as a “risk on” currency as buoyant markets benefit the City of London, which is the world’s leading financial and foreign exchange centre after New York.
Paul Mackel, the global head of FX Research at HSBC, noted that there is “a strong positive correlation” between the exchange rate and global sentiment.
He contends that the pound is relatively cheap, especially against the greenback as the pound has slumped by 24 per cent from levels in 2015, the year before the historic Brexit referendum. He added that the forces that boosted the US dollar to unexpected highs are fading and the tide could turn in 2023.
Economists at Morgan Stanley are in line with the majority of forecasters who expect the UK economy to suffer a torrid 2023 with growth the worst among developed nations.
“A bearish outlook for the UK has pretty much been a consensus view for the past few months, and remains so even as the pound staged an impressive rally against the US dollar in recent weeks,” said Wanting Low, a foreign exchange strategist at Morgan Stanley.
The investment bank listed the pound as a potential market surprise in 2023 if the US dollar underperforms.
But UBS Global Wealth Management, however, expects the pound to slide to 1.10 against the US dollar in first quarter of 2023, and revive to 1.21 by the end of the year.
“Inflation is above 10 per cent and even the BOE expects at least five quarters of negative economic growth. The Brits shot themselves in the foot with Brexit, so that’s another stagflation shock,” said economist Nouriel Roubini in his take on the UK economy’s outlook.
This high level of inflation has brought in its wake a plethora of strikes involving workers in the transport and health sectors, with the government facing a problem of how to finance higher wage settlements.
According to the Bank of International Settlements (BIS), the UK’s borrowing is already topping 100 per cent of gross domestic product (GDP) and any new borrowing would be at interest rates of 3.5 per cent or more.
The BIS said that as at the second quarter of 2022, total credit to the British government, corporations and households have reached a staggering £6.45 trillion, or 257 per cent of GDP.
These factors will limit the UK central bank’s ability to raise interest rates markedly, which is why many strategists feel the pound will continue to stay weak in the coming months.
Latest official forecasts show the UK economy contracting by 1.4 per cent in 2023. Not too long ago in March 2022, in the early days of the Russia-Ukraine war, the projection for 2023 was for 1.8 per cent growth.
