Politics, Inflation and Recession: British Illness Weighs the Pound

The pound traded between less than 80 pence and more than $1.40 to the euro ahead of the Brexit vote. Since then, it has lost more than 20% against the greenback and more than 10% against the single European currency.

Political uncertainty, rising inflation, a possible recession: the downsides to the British economy are keeping the pound sterling at an all-time low against the dollar and falling against the euro, which is also depressed.

The pound, a barometer of the United Kingdom’s attractiveness to international investors, is building at around $1.16 amid the Covid-19 shock, a level it only reached for a week in early 2020.

Prior to that, the British currency had not sold this much since 1985.

Many currencies are struggling against the dollar, encouraged by the US Federal Reserve’s (Fed) willingness to continue raising its key rates.

The Old Continent’s currencies have also been hit by the war in Ukraine and the energy crisis, with the threat of a total interruption of Russian gas supplies, which have already been limited.

Despite the Bank of England starting to raise its key rates at the end of 2021, the pound in particular has suffered more than 15% against the dollar and looks set to continue this tightening.

Against the euro, the pound has fallen 2% since the start of the year due to difficulties in tightening monetary policy by the European Central Bank.

Towards a historic decline?

The United Kingdom has the highest inflation rate of more than 10% a year among the G7 countries. The Bank of England estimates that this could rise to 13% in October.

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Private banking analysts are even more pessimistic: Citi estimates that the peak could reach 18.6% in early 2023, while Goldman Sachs is pushing 14.8%… but the disaster scenario is 22%.

Capital economists believe the pound could hit an all-time high of $1.05 due to a central bank focused on fighting inflation and a toxic cocktail unable to support the economy.

According to them, the BoE should stop tightening its monetary policy in the coming months, but it cannot ease as inflation persists.

Downside risks to the British currency have increased as “Prime Minister Liz Truss’ favorite threatens to backtrack on Brexit deal”.

Rishi Sunak, another of Boris Johnson’s candidates, said it would be ‘irresponsible’ to ignore the risk of a loss of market confidence in the UK as Ms Truss proposed new spending measures to tackle the cost of living crisis.

Derek Halpeny, analyst at MUFG, warns that if Ms Truss is elected, “this lack of credibility mentioned by Mr Sunak could cause the pound to fall further”.

Economists say the effects of leaving the European Union will continue to weigh on the United Kingdom’s currency.

The pound traded between less than 80 pence and more than $1.40 to the euro ahead of the Brexit vote. Since then, it has lost more than 20% against the greenback and more than 10% against the single European currency.

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