(Bloomberg) — The pound has rallied more than 10% from last week’s lows against the dollar but most strategists are sticking to bets that the UK currency will resume losses, with some predicting a new record low by year-end.
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Entering its sixth straight day of gains, sterling is poised to post its longest rally since April 2021, bouncing off last week’s record low of $1.0350.
Bank of England interventions to shore up the country’s bond market have boosted the pound, but have also ramped up expectations for UK interest-rate rises, which strategists at Barclays say “may translate to a weaker pound down the line.”
Standard Chartered Plc and Royal Bank of Canada both expect sterling to weaken almost 10% from current levels by year-end after government policy missteps undermined confidence in the currency. Nomura Holdings Inc. and Morgan Stanley are among those forecasting it will slip to parity during the same period, according to data compiled by Bloomberg.
The pound tumbled to its current all-time low of $1.0350 on Sept. 26, recovering as the government backed off its pledge to scrap a proposed tax cut. It was at $1.1380 on Tuesday.
Here are some comments from strategists about what might lie ahead:
Deflating Rate Rise Expectations
Economists at Barclays are on the dovish end of market expectations for the BOE, and expect a terminal rate well below market pricing above 3%.
“Given the MPC’s hiking path to-date in this cycle we concur that risks are for a smaller amount of tightening than market pricing,” currency strategists Lefteris Farmakis and Themistoklis Fiotakis wrote in a note. “This would effectively amount to yet another decision to let the currency bear the brunt of the adjustment at the cost of higher inflation for longer.”
As a result, they believe sterling is exposed to further downside risks once short-term bearish positions have been cleared out, particularly in EUR/GBP where the rebound has been most pronounced
Ratings Risk
The government’s U-turn on its tax-cut plans shaves only around £2 billion off an overall reduction of around £45 billion, according to ING currency strategist Francesco Pesole, who says it isn’t a game changer in terms of the country’s finances and continues to see “an elevated risk that the UK will face a rating downgrade.”
S&P Global Ratings cut the UK’s credit outlook to negative from stable last week, citing the country’s fiscal health over the next two years, while Moody’s Investors Service has warned that the government’s stimulus could do permanent damage to the country’s public finances. S&P’s next scheduled publication on the UK’s sovereign ratings will be on Oct. 21.
Wider Deficits
The rollback of the tax cut doesn’t change the UK’s current account and fiscal deficits that are in excess of 7% of GDP, said Divya Devesh, head of Asia foreign-exchange research at Standard Chartered in Singapore
That’s as the BOE has a limited amount amount of reserves to defend the currency and is likely to induce a recession with interest-rate hikes, he said
It’s certainly difficult to rule out parity with the dollar entirely, though sterling is likely to settle around $1.05 by year-end
Deeper Stagflation
The pound will trade at $1.04 into the new year as it’s “expected to remain under pressure as the UK economy stumbles deeper into stagflation, the current-account deficit worsens, and policy uncertainties remain elevated,” said Alvin Tan, head of Asia foreign-exchange strategy at Royal Bank of Canada in Singapore
Energy Crisis
The pound may drop to $1.05 by year-end as “a northern hemisphere winter of despair will drive sterling lower as Europe and UK energy crisis implodes the economy,” said Stephen Innes, managing partner at SPI Asset Management in Singapore
UK real yields are far too low to attract money and will need the BOE to hike rates “massively” to ensure the currency is supported, however this will just crush the economy even more and hurt the pound
Policy Missteps
Policy missteps and global recession risks “can push GBP down significantly” over the next month, Commonwealth Bank of Australia strategists Joseph Capurso and Carol Kong in Sydney wrote in a note
Still, “if the UK government bond market can settle, GBP can continue to track higher”
(Updates pound price, adds commentary)
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