A confluence of events keeps the currency from ending its fall.
Recently, the pound has plunged to levels not seen against the dollar since the mid-1980s, following the announcement of £45 billion in unfunded tax cuts by the UK government. At one point, sterling hit a 35-year low of 1.03 against the dollar.
“The currency has fallen close to 10% on a trade-weighted basis in a little under two months,” ING economic analysts wrote on September 26. “That's a lot for a major reserve currency.”
Giles Coghlan, the chief currency analyst at London-based brokerage HYCM, says the recent sell-off in sterling is a sign that markets are undecided about the size of the announced tax cuts, how indiscriminate they are and the risk they pose to inflation. They come when most central banks, including the Bank of England, are looking to reduce inflation by hiking interest rates.
On September 28, the Bank of England, which had earlier announced plans to scale back its purchases of UK debt, was forced to temporarily intervene in the gilts market with time-limited purchases to prevent prices of long-dated UK gilts from spiraling out of control and avert a financial crisis.
Many also anticipated an emergency interest rate hike from the bank. The central bank’s chief economist, Huw Pill, said it would comprehensively assess the macroeconomic and monetary situation ahead of its next meeting in early November before deciding on monetary policy.
But hiking interest rates by 150 bps wouldn’t have made much of a difference, according to Coughlan. “The pound [was] falling because of a loss of confidence. This is now going to have to play out in the political sphere.”
George Hulene, assistant professor in finance at Coventry University’s School of Economics, Finance and Accounting, says the UK government now needs to do something substantial to reassure financial markets how it is going to plug the £45 billion gap its tax cuts have left in the public finances. Prime Minister Lizz Truss and Chancellor of the Exchequer Kwasi Kwarteng have yet to reveal details of how they will fund their significant tax cuts.
“For the current sell-off in sterling to stop, the government has to show what actions it is putting in place to remove the indiscriminatory aspects of their fiscal policy and how the economy will not be hit by unfunded tax cuts,” says Hulene.
If these details aren’t forthcoming, it is likely to be another massive blow to the pound, which had regained some of the ground it had lost over the last few days, ending the day’s trading at $1.1 on September 29, he adds. However, Hulene notes that sterling’s problems began long before Kwarteng announced the tax cuts.
No Short-Term Answers
In 2014, the pound was up almost 1.7 against the dollar. But immediately after the Brexit referendum result in 2016, the reserve currency experienced its biggest fall within a day in 30 years, reaching as low as $1.34 at one point.
There were two further substantial and sustained falls in 2017 and 2019, which saw the pound record new lows against the euro and the dollar, according to the UK economics think tank, the Economics Observatory.
More recently, other factors — the UK’s proximity to the war in Ukraine, continued deadlock with the EU regarding Brexit and the Northern Ireland Protocol agreement and a strengthening dollar, which has been gaining since the US Federal Reserve started hiking interest rates in March — have also weighed on the pound, say experts.
The best-case scenario for sterling would be peace in Ukraine, a resolution to the Brexit Northern Ireland Protocol impasse with the EU, and falling inflation in the US, which could spell the end of the Fed’s rate-hiking cycle, according to HYCM’s Coghlan.
Nonetheless, stronger than expected US economic data published on September 29, which saw personal consumption figures being printed at 2% versus the expected 1.5%, is likely to give US Fed Chairman Jerome Powell little excuse to hold back on further rate rises, said William Marsters, a senior sales trader at Saxo UK.
The war in Ukraine has also ramped up with Russia’s annexation of Ukraine’s Donetsk, Luhansk, Kherson and Zaporizhia regions, and the EU hopes that the UK’s current financial woes could lift the ‘deadlock’ on the Northern Ireland Protocol.
Meanwhile, concerns are growing about how the current volatility in sterling and FX markets could impact CFOs' balance sheets.
The hit to corporate earnings from the current escalation of FX volatility, particularly in sterling, could reach more than $50 billion in impacts on earnings by the end of the third quarter, according to Wolfgang Koester, a senior strategist at Kyriba, which publishes a quarterly Currency Impact Report based on earnings reports for publicly traded North American and European companies. These losses stem from these companies’ inability to monitor and manage their FX exposures accurately. “Companies with a major FX hit are likely to see their enterprise’s value, or earnings per share, go down,” he says.