We now have Rishi Sunak as Prime Minister and he is sticking with the previous chancellor “Newly confirmed finance minister Jeremy Hunt must keep investors calm about Britain's debt mountain, avoid causing a deep recession and work out a way to stop the Conservative Party from splintering again - and all of it by next Monday.” (REUTERS) This will be a hard task and the market's relief of a Sunak victory in terms of becoming Prime Minister will end in our view and the GBP rally will fade.
UK Facing Recession
The market will move back to focusing on the big fundamentals which are bearish for the UK and bearish for the GBP. The size of the task facing the Government is huge in terms of avoiding a recession: “The UK’s debt-to-GDP ratios are set to rise, and net gilt supply may exceed GBP250bn which would be a new record high. The UK’s fiscal deficit looks likely to go up to 6% of GDP. The UK’s core balance (i.e. current account balance + net foreign direct investment) has declined from a 2% surplus to an 8% of GDP deficit in the last two years.
UK Cost of Living Crisis
“The intensity of cost of living pressures and the fact that market interest rates are still above their pre-mini-budget levels mean we continue to think that the economy will shrink in H1 2023," (Andrew Goodwin at Oxford Economics.) It will shrink and the UK looks set for a recession.
The impact of the energy crisis in the UK will hit the consumer hard: As many as half of British households may be facing fuel poverty because of the inexorable rise in energy prices according to energy provider EDF. "When you look at the figures more than half of UK households will be in fuel poverty in January, meaning they will have to spend more than 10% of their disposable income on their energy bill," (Philippe Commaret EDF)
The economic backdrop is grim, and we also have the prospect of more interest rate hikes from the Bank of England which will weigh on growth but far will rates go on the upside?
Bank of England and Rate Hikes
Markets are pricing in a 75-bps rise next week and the market sees the Bank Rate peaking at about 5.00% however Deputy Governor Ben Broadbent recently noted: "whether official interest rates have to rise by quite as much as currently priced in financial markets remains to be seen." Many in the market are now speculating rates could peak at 4%.
Even if the bank Of England raises rates to 5% this won’t help the GBP – The Fed is on course to do the same and rate hikes will hurt growth less in the US than in the UK. The US economy is doing better than the UK. Exposure to the energy price shock caused by the Russia-Ukraine war hits Europe and the UK far more than the US.
Big Fundamentals are Bearish GBP/USD
The USD has seen weakness this week against other major currencies on the view the Fed will turn more cautious going forward but this view is now discounted, and we think the Fed will continue to remain hawkish. The USD historically does well when the global economy slows and we have this scenario firmly in place with a global recession likely.
We have seen a big rally after the disastrous mini budget under previous Prime Minister Liz Truss. It's just a relief rally on the budget being rolled back and a Sunak victory but the big fundamentals remain bearish. We think the rally should fade into resistance at 1.1600 - 1.1700. We think a return to the 1.0950 level is likely with a possible overshoot to 1.0700 if we get risk off in the markets.