The recent slowdown in Britain’s previously surging inflation has had a significant impact on the value of the pound, which had been performing strongly as the best-performing currency among the Group of Seven (G7) developed economies just a day ago.
Date: July 20, 2023
Place: New Delhi, India
On Wednesday, the pound experienced its most significant one-day drop against the dollar since March, reflecting the decline in British government bond yields as prices surged. However, London blue-chip stocks rallied, particularly in interest-rate-sensitive sectors such as homebuilders and landlords.
The decline in sterling comes as no surprise, considering the positioning data that indicates speculators currently hold their most valuable bullish bet on the pound since 2014. With the release of data showing a slower inflation rate of 7.9% in June, below the forecasted 8.2% and down from May’s 8.7%, more traders may now choose to secure their profits.
As a result, the likelihood of the Bank of England (BoE) raising the base interest rate above 6% has become almost nonexistent, dampening some of sterling’s appeal. Consequently, expectations are being repriced, potentially weighing on Sterling’s performance, particularly against the dollar.
ABN AMRO, a financial institution, projects that sterling will weaken to $1.25 by the end of the year, down from its current level of around $1.29.
Investors have generally perceived the Bank of England as lagging in its efforts to combat inflation, while consistently relying on UK interest rates to continue rising even after rates in other countries, like the United States, start to stabilize.
However, even if rates in the UK peak between 5.75% and 6.0%, as currently anticipated by the markets, Britain would still offer more attractive returns than the United States, where rates are expected to rise to approximately 5.4% from the current level of about 5.125%.
BNY Mellon Investment Management financial economist Sebastian Vismara stated, “The work is not done yet for the Bank of England. As both wage growth and services CPI inflation remain stronger than the Bank forecasted in May, and signs of a turning point in inflation are only tentative for now, interest rates will be raised further.”
It is worth noting that the UK still has the highest inflation rate among the G7 economies. In the United States, consumer price pressures stand at just 3%, while inflation in the eurozone is at 5%.
Although falling energy prices have relieved consumers and businesses, another decrease is expected in July when regulated household energy tariffs will be reduced. Nevertheless, mortgage rates are rising rapidly, and grocery inflation remains in double digits, contributing to a cost-of-living crisis for British households.
Despite the recent drop following the inflation data, the pound remains up by nearly 7% against the dollar this year, previously outperforming all other major currencies. However, the Swiss franc, which has appreciated nearly 8% against the dollar, has now taken the top spot.
On Wednesday, the pound experienced a 1% decline, reaching as low as $1.2898, marking its largest one-day fall since the banking turmoil in mid-March. Simultaneously, two-year gilt yields fell by approximately a quarter of a percentage point, also the most since March, reaching one-month lows at around 4.84%.
The growing difference in interest rates between the United States and the United Kingdom has been a significant driver for the pound’s performance. The gap between U.S. and British 10-year borrowing costs reached its widest point since early 2009, at a premium of 65 basis points just a week ago.
Joseph Calnan, a corporate FX dealing manager at Moneycorp, highlighted, “Looking to the currency, these overshoots and economic signals have been a core driver of FX markets over the past 6 months. Once inflation eases off, if the drop is sharp enough, we will likely see the pound falling with it – so we need to be prepared for that, too.
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