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It’s been four and half months since we last wrote about the pound, which doesn’t feel like long but is almost three Liz Trusses.
In a sense, not much has changed. As it was back then, sterling is the G10’s best year-to-date performer (an arbitrary measure but it’s as relevant as any arbitrary measure):
As it was back then, the longer term view is . . . less favourable (this is Bloomberg’s pound index but cable looks similar):
Rabobank’s Jane Foley summed up the general meh-ness of the situation thusly:
The pound is currently holding on to the mantle of best performing G10 currency in the year to date. While this sounds impressive, it marks a recovery from the multi-decade lows that cable hit last September on the back of the Truss debacle.
The weakness of GBP last year was despite a persistent spate of rate hikes from the BoE and demonstrates that monetary policy tightening was unable to fortify the currency against a backdrop of concerns over UK growth and poor economic fundamentals.
While the market has been welcoming of Chancellor Hunt’s more conventional management of the UK economy, UK fundamentals remain far from robust.
Bloomberg’s Marcus Ashworth (no relation, afawk) similarly spies danger. He wrote in a column yesterday that “a Wile E. Coyote moment is beckoning for sterling”:
When the economy does start to turn south it could affect the currency in a number of ways — particularly if it alters the BOE’s rate trajectory. A less hawkish central bank will whip the prop from underneath the pound.
Unless something dramatic happens, the UK is headed for a long period of stagflation with little-to-no growth matched with stubborn inflation. The only reason for sterling to hold up in that scenario is if the dollar weakens faster. Hope, though, is never much of a strategy — in life or in currency trading.
As the Bank of England girds up for its 15th consecutive interest rate increase, due in just under a month, it’s worth considering whether the music is about to stop for sterling.
Nomura’s Jordan Rochester agrees that an inflection point may have arrived, encouraging clients to short cable in a note released last week. Here’s his reasoning:
— 1) Because UK disinflation is likely to be strong, with surveys and PPI all on the weak side; eventually those signals will likely be proven true, as they have done so far in the US;
— 2) too much priced by the market for the BoE meeting (68bp by year-end, could it end up being just one/two more hikes?);
— 3) CTAs are quite net long GBP;
— 4) UK data surprises likely to turn lower, as we progress through the late-cycle slowdown phase; what’s surprising is why isn’t there a bigger focus on the UK unemployment rate rising? And
— 5) global manufacturing growth continues to slide lower; it’s rare for GBP to outperform when large economies such as China are experiencing a slowdown.
The fly in the disinflationary ointment is services inflation, which Rochester suggests (in a further note today) seems to be disconnected from changing output prices, but more timely indicators suggests the flip is in:
A June note by Société Générale’s Kít Júckés puts sterling’s present situation in a longer context:
This pattern, of sterling suffering a vertiginous fall amid a crisis of confidence in the country’s economic management, followed by a crawl back up, is a familiar one. In real trade-weighted terms, the Brexit referendum took sterling to its lowest level since 1976, and the currency has been recovering ever since, albeit without getting anywhere near the pre-referendum level, let alone the dizzy heights it reached in the decade after the Bank of England gained independence in 1997. If UK rates rise as far as is currently priced into the UK curve (which seems both unlikely and dangerous), the pound will remain strong for just as long as those rates can outweigh the longer-term economic outlook.
Why does sterling behave like this? The title of Michael Stewart’s book about the UK economy between 1964 and 1977, “The Jekyll and Hyde Years” has always seemed a better description of sterling than the economy, brief periods of optimism unable to hide us from the long-term trends.
Júckés’ conclusion is that once the rate differential closes, a (re)test of EUR/GBP parity is likely in the “next couple of years”.
So what are the arguments against pounddoom?
— Upside risks to economic data are a decent one: the UK economy has been difficult to call all year, notably defying widespread predictions of a recession, with this morning’s public borrowing miss just the latest example of forecasts missing the mark.
— Inflation could also, despite all the signs it should be fading, remain sticky. A rebound in energy prices could also conceivably make a difference, by attracting inflows into UK equities.
— There’s also the great unknowable: the Bank of England’s Monetary Policy Committee itself. The MPC has been of quiet of late, with no speeches since its last meeting at the start of this month, but it is likely to be concerned by the UK finally seeing nominal wage growth.
Luckily for Threadneedle Street watchers, two of the most interesting members may soon break the silence: deputy governor Ben Broadbent (the king of consensus) and chief economist Huw Pill are both scheduled to speak next week.
If they both strike a hawkish tone, there’s a chance the sterling could find its legs for a little longer — but the yards are getting harder.
