Strategy blog: Sterling
The pound's slide against the dollar gathered momentum after Friday's fiscal package was announced, and on Monday morning it hit an all-time low in Asia of $1.03, down from $1.13 on Thursday and $1.35 at the start of the year. It is currently at $1.07. Christmas has come early for the media, and we now reportedly have an old-fashioned sterling "crisis" to go with the cost of living one.
The pound's fall will certainly help keep inflation higher than it would have been – by pushing input and competing product prices higher – and the unfortunate Monetary Policy Committee will probably have to raise interest rates further than they would have done. (There is some talk of an ad hoc MPC meeting, which we think is premature: such action at this stage could backfire – as for example happened with the "emergency" rate hikes at the time of the UK's exit from the Exchange Rate Mechanism).
Money and bond markets are already digesting this, alongside the prospect of more issuance. Implied peak policy rates in 2023 have now pushed above 5.5%, and the 10-year gilt yield has now risen by more than 50bp since Thursday, to 4.1% (its price has fallen by 5% since Thursday, a mini earthquake in bondland).
When sentiment is fragile – and momentum strong – it is foolhardy to offer confident trading calls. Sometimes the best advice is indeed "don't just do something, stand there". But we can offer some perspective:
The UK is not bankrupt, and has not gone ex-growth (or at least, no more so than the other big European economies). As we noted on Friday, the fiscal package may look incoherent economically, and provocative politically, but the UK government's balance sheet is in better shape than many (including the Office for Budgetary Responsibility and IMF) feared it would be two short years back. The big numbers were not actually as large as some had suggested.
That said, they landed in a context in which UK monetary policy has been looking (even) less resolute than in the US or eurozone of late. The MPC has been more equivocal on the need for higher rates: in the face of an 8-percentage point gap between CPI inflation and the policy rate at the latest meeting, one member opted for an increase in the latter of just one quarter of a point.
A significant part of the currency story even now is all-round dollar strength. The pound has fallen against the euro too, but by 3% since Thursday and by just 7% since the start of the year (compared to its 5% and 21% declines against the dollar over the same periods). The cable rate has fallen by more than the other big currencies against the dollar this year, but in trade-weighted terms (that is, all-round terms) its decline is a more modest 8%. The yen has fallen by more on this basis.
The corollary is that the pound is in fact not yet that cheap in all-round terms: we can't yet say that valuation alone makes it a compelling long-term buy.
We do not know when the pound will stabilise, but we do know that markets often over-react to news. Meanwhile, we have not been recommending gilts for many years, but as we noted on Friday, yields are closer to offering plausibly positive long-term real returns.
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