Bloomberg: The problems of the lira are deep, whoever is elected prime minister

Whoever becomes the new resident of 10 Downing Street will inherit a maelstrom of financial problems, notes Bloomberg.

Inflation in the UK is running at its fastest pace since the early 1980s. The Bank of England is tiptoeing towards interest rate hikes relative to its counterpart on the other side of the Atlantic. There are also the employment and supply chain wounds left behind by Brexit.

All this has left sterling teetering near levels last seen when the Covid-19 panic and lockdowns were in full effect.

Add in the UK’s long-term hoarseness, falling productivity, and “the new British government takes over in a difficult situation,” said Ulrich Leuchtmann, chief currency strategist at Commerzbank AG. “There is always the risk of a nasty spiral of higher inflation and a weaker currency.”

Investors and strategists agree: whether Foreign Secretary Liz Truss or former Finance Minister Rishi Sunak wins the leadership race, the forces behind the pound’s slide may prove beyond their power to reverse. face.

Volatile energy prices and a tight labor market have already left BOE policymakers vacillating between aggressive rate hikes and the need to cushion the economy from rising prices. With its open economy and huge current account deficit, the UK is vulnerable to global strife. Inflation will outpace any of its major European countries in the next two years, according to economists polled by Bloomberg.

After Brexit, sterling has become a more “peripheral” component of investors’ currency portfolios, according to Bank of America strategist Kamal Sharma. This leaves it highly exposed to a global purge of investment sentiment as Russia’s invasion of Ukraine continues and China’s fight against Covid hits the domestic economy.

As Britons feel the sting of a weaker pound when buying goods shipped from abroad, the country’s central bankers are watching the impact on rising prices as costly imports add to inflationary pressure. The decline in the Bank of England’s preferred gauge of the pound’s strength this year has added about 0.5 percentage points to the pace of inflation, according to Bloomberg Economic’s SHOK model.

“Even if the economy sweeps into the positive column for GDP growth for now, things will look very recessionary,” Standard Bank G-10 strategist Steven Barrow wrote in a note to clients this week. Barrow predicts an increase in strike action amid the kind of “union militancy” last seen in the 1970s and 1980s.

BofA sees UK recession in 2023 on higher inflation and interest rates

More expansionary fiscal support from the government may seem the obvious solution to bolster struggling households, but it risks pushing up inflation and making the BOE’s job harder. The candidates’ promises to cut taxes could add fuel to rising prices and call for additional central bank tightening.

Barrow sees the pound sinking further to $1.15 against the dollar in the coming months. Sterling’s fall of more than 11% against the dollar this year has forced BOE policymakers to take note: Catherine Mann said she supports a 50 basis point hike to help support the currency, twice the size of of the BOE’s latest moves.

Interest rate gap

This may go some way to narrowing the central bank’s interest rate gap with the US Federal Reserve. The BOE has raised interest rates by 115 basis points over six months, compared to the Fed’s 150 basis points in half a year. Bloomberg’s index of dollar strength is at its highest level in at least 18 years.

To be sure, the pound isn’t the only one facing the US currency’s rise. Nor are the factors ailing sterling unique to the UK. The euro fell against the dollar for the first time in 20 years this month, while the ECB has just rolled out its first rate hike since 2011.

“A big deficit, high inflation and political turmoil is the fate of many countries,” particularly in Europe and the eurozone, said Amundi Asset Management portfolio manager Philippe Jauer, referring to the resignation of Italian Prime Minister Mario Draghi, which has plunged politics of the country in chaos.

These disasters may gain some ground for the pound against the common currency, but in six to nine months Bank of Montreal’s Stephen Gallo predicts the euro-sterling pair will move higher to 0.91 from around 0.85 now .

“There is limited rally potential regardless of who wins,” he said.

Using global equity markets as a proxy, the pound has become steadily more sensitive to global risk appetite.