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Pound Risks Bear Market Slide as New Prime Minister Glow Fades - BLOOMBERG

SEPTEMBER 07, 2022

(Bloomberg) -- The honeymoon is already over for Britain’s latest prime minister in the currency market.

The pound bounced off a two-year low as Liz Truss took over on Tuesday, yet the rally is fading as she prepares to face scrutiny in Parliament on Wednesday. That’s leaving the currency resuming this year’s downtrend, putting it on the edge of a bear market that could spur a bigger sell-off.

Investors have been getting rid of sterling assets given surging inflation and the likelihood of a recession in the UK. While Truss’ mooted plans may help households through an energy crisis, paying for them with an government spending spree risks stoking up future problems for markets.

“A change of leadership is usually pound positive, especially when up to £130 billion of fresh deficit spending may be on the agenda. But the current crisis is unlike any we’ve seen in the recent past,” said Jordan Rochester, a strategist at Nomura International Plc, once nicknamed “Mr. Brexit” for his prognostications on UK political twists.

Artificially lower energy prices for consumers would reduce the pressure on the Bank of England to deliver such aggressive interest-rate rises in the near term, but that’s at the cost of the government paying “a lot more,” widening the country’s trade deficit, he argues.

Liz Truss Pledges Action on UK’s Soaring Energy Bills This Week

“It’s a recipe for the balance of payments to continue to deteriorate, the UK’s terms of trade to worsen and with it the the pound’s value to fall,” Rochester said in a note, expecting the pound to drop to $1.10 by the end of October, and $1.06 by year-end.

The currency has already tumbled more than 15% this year. It traded down as much as 0.6% to $1.1452 in London on Wednesday, nearing the $1.1412 low hit during the pandemic in 2020. Below that would be the weakest since 1985, with a fall under $1.14 putting it into bear market territory. 

Investor sentiment is also being tested by a potential face-off between the Truss government and the BOE over the way it conducts monetary policy, which could compromise the central bank’s long-held independence. 

The BOE expects the UK to fall into a long recession, though Truss aims to spur growth through tax cuts. The BOE’s chief economist Huw Pill told lawmakers on Wednesday that the new government’s energy moves could reduce price pressures, yet he said a recent forecast by Goldman Sachs Group Inc. strategists of UK inflation hitting 22% was “plausible.”

Truss Says It’s Bank of England’s Job to Control Inflation

That’s an outlook keeping sentiment negative on the pound in options markets, with traders betting the next few months will see plenty of volatility. A gauge of swings over three months versus the dollar has hit its highest since the aftermath of the pandemic in recent days.

“It’s still tough to find significant reasons to be long sterling and ultimately it still feels like it has a little further to go before we reach the bottom,” Jeremy Stretch, head of G-10 currency strategy at Canadian Imperial Bank of Commerce, said on Bloomberg TV. “If we go down through $1.14, then I think the $1.10 threshold will start to come into view.”


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