© Reuters November 9, 2021 In this picture, British pound coins are seen in front of a stock graph. REUTERS/Dado Ruvic/Illustration
By Mike Dolan
LONDON (Reuters) – Although fears of another “sterling crisis” have been a major concern for decades, they are hard to overcome this time with Britain’s fourth prime minister in office in six years.
In an interview last month, Bank of England Governor Andrew Bailey rejected the idea of a UK currency or balance of payments, blaming the pound’s 20% fall against the greenback last year on the strength of the US dollar. levels not seen since the mid-1980s.
“It’s not a crisis in my view.”
But the fact that the pound and UK government bond prices have fallen at the same rate raises alarm bells that there is something far more sinister than the love of the dollar or the flow of volatile currency markets.
Foreign investors appear to be venturing into the toxic mix of falling UK inflation and inflation expectations, just as interest rates are rising sharply as government borrowing rises again under the new PM Lease Trust. What’s more, Truss appears keen to cut taxes despite spending more than £100bn more to ease the winter energy price crunch.
With uncertainty over post-Brexit trade policy hanging over, overseas financiers appear to be moving away from UK assets.
In this week’s headline-grabbing research report, German Deutsche Bank (ETR:) said the risk to the UK’s balance of payments was rising and the risk profile on government bonds was rising and borrowing was becoming more expensive, so foreign investor confidence could not be taken for granted.
Moreover, sterling’s trade balance index – down 7% since January – may need to fall another 15% to drag the country’s record current account deficit above 8% of GDP to its 10-year average.
“If investor confidence erodes further, this dynamic could become a self-fulfilling payments crisis, with foreigners unwilling to fund the UK’s external deficit.”
Introducing one of the darkest periods in the UK’s post-World War II economic history, the phrase “The Spectacular Crisis” resonates deeply with many in Britain as the country struggles to retain the confidence of foreign investors it needs to finance its long-term balance sheet. Payment defects.
As these recent crises – 1967, 1976 and 1992 – tended to occur in fixed or semi-fixed exchange rates, resolution often meant deep currency devaluations to make UK assets cheap enough to attract foreign capital.
At least the first two would need a conditional bailout from the International Monetary Fund to steady the ship and prop up the pound at a new rate that would allow the government to borrow again at affordable rates in the bond market.
But in the year Since sterling left the European currency in 1992, it has floated freely and the Bank of England has been printing money and buying bonds to support government borrowing for the past 15 years, the idea of a classic sterling crisis and external funding crisis. Dispersed.
Of course, the pound has fallen at times – but the lack of inflation over the past two decades has allowed the BOE to underwrite the gilt market during emergency government borrowing, and a low exchange rate has allowed foreign capital to quickly restore balance and exports. A lift to the bargain.
Top picks: Sterling and gilts sell off https://fingfx.thomsonreuters.com/gfx/polling/gdpzyxwxrvw/posted%20image%201662474758002.png
UK Twin Deficit outlier https://fingfx.thomsonreuters.com/gfx/mkt/klvykazabvg/One.PNG
UK Current Account and Sterling https://fingfx.thomsonreuters.com/gfx/mkt/dwpkrxaxqvm/Two.PNG
Summer of 76
Times have changed. Resurgent inflation, rising interest rates and the Bank of England’s active participation in bond sales to reduce its balance sheet all change the equation as demand for foreign currency trades and current account gaps balloon.
Deutsche lamented the parallels with the 1976 Stealing crisis – which resulted in a painful IMF bailout, fueled by energy shocks, heavy fiscal spending and staggering weakness. And the new prime minister needs to convince investors she needs to strike the right balance because “broad, weakly targeted fiscal policy will widen the twin deficits and exacerbate inflation”.
If overseas funds dry up, the Bank of England may start buying bonds again – but this will disrupt inflation and its plans and may increase inflation and require more borrowing.
Offshore funds recognize that sterling may appear relatively cheap under fair value models but cannot see a way around a number of domestic problems.
Cesar Perez Ruiz, chief investment officer at Pictet Wealth Management, said despite the reviews they were still “very negative” on the gilt and the pound. “A lot of people see the UK as a new market,” he said. “And in that case, the victim tends to be the currency.”
Nomura strategist Jordan Rochester also thinks it’s good to short the pound because the government’s £100 billion spending plan to cover household energy bills, unlike the similar pandemic bailout two years ago, will further worsen the UK’s balance of payments and terms of trade. Increase in debt costs.
For HSBC strategist Dominic Bunning, the risk to sterling remains on the downside despite short-term recoveries.
“The UK may have a new prime minister, but the economy and currency face the same old challenges: weak growth and high inflation, imbalances and dependence on foreign financial flows.”
Sterling and the UK Yield Curve https://fingfx.thomsonreuters.com/gfx/mkt/zjvqkrermvx/Three.PNG
UK 2-Year Premium Yield https://fingfx.thomsonreuters.com/gfx/mkt/xmvjoalaxpr/Four.PNG
The opinions expressed here are those of the Reuters columnist.
(By Mike Dolan, Twitter (NYSE::): @reutersMikeD; Chart added by Andy Bruce; Editing by David Evans)