By Saikat Chatterjee

LONDON (Reuters] – One trade in the volatile currency market is a simple one: selling British pound.

The fifth largest economy in the world is currently facing a very unhealthy mix of low growth and rising inflation. British citizens have become the preferred medium to voice their disapproval. On Wednesday, official data showed that the inflation rate reached a forty-year high of 9%. This is more than four-times what Bank of England had set for 2%. However, Britain will face its worst ever cost of living crisis until late next year according to Reuters.

Despite being the central bank that raised interest rates the most in December, the BoE’s future trajectory is much less steep than those of some global counterparts such as the U.S. Federal Reserve.

Although the problems facing the British economy are similar to those faced by other policymakers, there are a few additional factors that weigh heavily on the pound.

There is a risk of conflict between the European Union and Britain if Britain threatens a law that would override certain parts in a post-Brexit Northern Ireland trade deal.

Protracted trade disputes could further increase the current account deficit and weaken the currency. A second factor is the increase in tax burdens. These are the results of massive temporary relief given to sectors that were struggling during the pandemic. It has also hit employers and workers already suffering from rising energy bills and added to the economic drag. Wouter Sturkenboom is chief investment strategist in EMEA, APAC. He stated that a UK recession was almost certain because of the economic headwinds. Northern Trust Asset Management. The money markets expect just 120 basis points in cumulative rate increases by year’s end, compared with the Fed’s almost two-thirds of a percentage point. The European Central Bank, which is more conservative than the Fed, will raise interest rates by 108 base points in that time period.

Jane Foley of Rabobank FX strategy says the market has slashed its UK rate rise expectations over recent weeks as recession risks increased. According to Reuters, 35% percent of the respondents predict a recession within a single year.

Kaspar Hense of Bluebay Asset Management, London said that his portfolio was lacking the currency.

He stated that the pound had the worst outlook of all major currencies because the central bank has been reluctant to increase interest rates aggressively, which means it has the lowest inflation adjusted yield among its competitors.

The war in Ukraine increased price pressures. UK growth expectations fell and consumers lost confidence due to the rising inflation and the prolonged conflict. There were also concerns over the effects of COVID lockdowns and the effect on China’s growth, Britain’s third largest trading partner.

Citibank’s indexes measure the economic performance of data and expectations. They are less for Britain than the United States or Europe, suggesting that the economy is facing growing headwinds.

TAKE A TURN TO THE WORST

It is likely that the British rate-hike cycle won’t last. HSBC strategists have calculated that the spread of 3-year and 1-year interest rates is 1.5%. Then, interest rates are expected to peak in June 2023 at 2.5%. After this, rate cuts will be implemented.

HSBC reported that “the consumer outlook has changed dramatically, as real income squeeze is hard on the economy. This will make it extremely difficult for Bank of England (BoE) to deliver any close to what was priced in the forward rate market.”

HSBC expects that the pound will end 2011 at $1.20. This is 8% less than the $1.30 prediction.

The pound traded at $1.24 on Wednesday. This is a drop of nearly 8% this year, and it was not far away from the May 2020 low of $1.21, which was touched last week.

Rapid transformation of the British currency into an icon for the risks of stagflation in the global economy was witnessed.

Early December saw hedge funds continue to bet against the dollar while favoring the pound. That has been flipped six months later to be the largest short pound wager in over two-1/2 years. Unfortunately, the outlook is grim. Risk reversals of the British pound for three months, which are a measure of sell-to-buy options, have reached one month highs. Expected price swings however are still at near two year highs.