Analysis: Clubbed pound faces long road back as investor confidence plummets

A worker walks over a mosaic of pound sterling symbols laid on the floor of the entrance hall of the Bank of England in London, in this file photograph from March 25, 2008. REUTERS/Luke Macgregor

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LONDON, Sept 26 (Reuters) – The pound’s fall to historic lows leaves it at par with the dollar. Whether or not it reaches the token level, investors say the new UK government has dealt such a blow to the UK’s standing with the markets that rebuilding confidence could take more than emergency rate hikes of interest.

The pound, the most visible indicator of investor perception of the UK, plunged to $1.0327 on Monday, an 8% drop since the time UK Finance Minister Kwasi Kwarteng , unveiled a “mini budget” of 45 billion pounds ($48) on Friday. billion) of unfunded tax cuts.

The prospect of borrowing more to pay for tax cuts for the wealthy and a “new era” of economic policy in which efforts to stimulate economic growth seem to take priority over public finances spooked markets.

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UK government bond prices crashed, the pound fell against a range of currencies from the euro to the Argentinian peso and on Monday morning economists were calling on the Bank of England to announce a rate hike to halt the rotting.

Money markets priced in UK interest rates of 5.4% in February, a 300 basis point hike from current levels that would hammer the economy. Still, the rapid rise in yields investors are now receiving for owning UK bonds hasn’t helped the pound much.

“Once a market starts to move with this kind of momentum, it’s hard to put a figure on where it (in pounds) is going to go down,” said Seema Shah, chief strategist at Principal Global Investors, which manages around 500 billions of dollars in assets.

“But as an investor you take a long-term view. If you look at the UK as a place to invest over five years, for me that’s a no.”

Falling pound and soaring UK borrowing costs

Predicting the short-term direction of currencies is notoriously difficult. Yet some such as Nomura Holdings were looking beyond any immediate action by the BoE and predicting that the pound would fall below parity with the dollar by the end of November.

The pair would be a big move of 7% from where the pound was trading at 6:00 p.m. GMT on Monday, but 3% from its previous lows.

Hedge fund manager Louis Gargour of LNG Capital, which has undisclosed positions on the pound, said it would be a “forehand to 95-96 cents” until the government and BoE stabilize sentiment.

The BoE said late Monday that the bank would not hesitate to raise rates if needed to bring inflation back to its target, and it was watching markets closely. Many traders had argued that the bank should increase now.

Britain’s finance ministry said Kwarteng would set out a “medium-term fiscal plan” on Nov. 23, alongside the Office for Budget Responsibility’s growth and borrowing forecasts.

IS NO LONGER STABLE

Not everyone sees more pain for the pound.

In a note titled “Give the pound a chance,” UBS called the reaction an “impulse sell-off” and said that after a “quick sell-off tsunami,” “we need to ask ourselves if the outlook for the pound is really disastrous from here”.

The fall of the pound should also be seen in the context of a general surge in the dollar which has seen the yen and the Swedish krona fall by similar amounts in 2022.

Against the euro, the pound is only at its lowest in two years, although it is down 3% since Friday.

The alarm bell is ringing for the pound

Crucially, investors say the economic shift in Prime Minister Liz Truss’ government is another reason to steer clear of UK assets, already undermined by a decade of weak growth, the 2016 Brexit referendum and dependency on Britain. Britain to foreign investors to finance its large current account deficit.

“It’s a shift from the government’s agenda and I think (the impact) will last for some time,” said Bethany Payne, global bond portfolio manager at Janus Henderson Investors, calling the government a ‘irresponsible’ for announcing its policies without economic forecasts.

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There are no easy options for rebuilding credibility.

If the BoE is forced to walk away from a scheduled meeting, it could escalate the situation by emboldening traders to bet on what more it could do. If the BoE holds back a rise, expect wilder swings.

“A central bank intervening to stabilize currencies is never a good sign,” said Chris Huddleston, CEO of brokerage firm FXD Capital, saying he expected a rate hike from the BoE.

If the government sticks to its guns for more unfunded tax cuts, confidence in the UK is unlikely to recover soon. A change in stance also seems unlikely, given that Truss’s team is confident that its policies will pay off in the medium term through faster economic growth.

“People will look at the UK and think it’s not a stable market,” Payne at Janus Henderson said.

“I don’t think we’ll be pariahs, but when you have such volatility in the market, people usually back off until the dust has settled and it hasn’t happened yet.”

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Reporting by Tommy Reggiori Wilkes and Dhara Ranasinghe Additional reporting by Julien Ponthus in Paris and Nell Mackenzie in London; Editing by Aurora Ellis

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