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Things Go from Bad to Worse for the British Pound

Published 14/01/2025, 21:00
© Reuters.  Things Go from Bad to Worse for the British Pound

© Reuters. Things Go from Bad to Worse for the British Pound

GBP/USD
-0.35%
EUR/GBP
-0.01%
FLG
0.01%

ExchangeRates.org.uk - Pound Sterling is the worst-performing currency in the G7 this year.Rising yields are usually a positive for a currency, but UK yields have hit extreme levels and may force government spending cuts or higher taxes.

Wednesday’s inflation data is important but may prompt an unusual reaction in the pound.

The pound’s losing streak continued on Tuesday as fresh selling pushed GBPUSD to close to 1.21 and EURGBP rallied to 0.845.

Sterling is the worst performing G7 currency this year, and by a wide margin.

It has fallen by –2.7% against the USD.

The second worst performing currency, the euro, has fallen only –0.9%.

Oddly, it’s not clear what is driving the weakness.

The BoE has not suddenly shifted dovish, and UK data has been stable.

Furthermore, yields have been moving higher, which is usually positive for a currency.

It seems the moves are driven more by a re-assessment of the pound’s strong performance in 2024 when it spent much of the year tailing the USD as BoE were slow to cut rates.

Additionally, the rise in yields is putting pressure on government finances and risks are rising that fiscal spending plans will need to be binned.

Pound Under Pressure

Yields have been rising all over the world for a variety of reasons.

In the US, a bump higher in inflation, strong economic data and the expectation of inflationary policies from the new administration have all contributed to “higher for longer” rate pricing.

Yields in the EU has risen as inflation changed course with three consecutive monthly higher readings.

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Over in the UK, yields have stayed relatively high due to sticky services inflation, the relative hawkish stance of the BoE and the expansionary budget, but as they rose in tandem with the global rally, they started to cause concerns about the viability of spending plans.

The jump in borrowing costs eroded most if not all of the financial cushion against Chancellor Reeves’ fiscal rules.

The risk is that Chancellor will be forced into cutting public spending and/or raising taxes – the next scheduled fiscal update, the Chancellor’s Spring forecast, is due to be held on 26 March.

The UK government has tried to shore up sentiment and prime minister Starmer announced on Monday that he has “full confidence” in Chancellor Reeves.

Even so, gilts are trading at extreme levels and the yield on the 30Y gilt is at 25-year highs.

Consequently, the pound has collapsed despite improved rate differentials versus other currencies.

“Gilts have remained under pressure, following the global bond underperformance.

There is now a tangible risk that 10-year yields will be trading above 4.90% before tomorrow morning’s UK CPI print.

Should that come in hotter than expected, selling pressure can intensify into the 5.0% handle and potentially beyond,” noted ING on Tuesday.

Wednesday’s session will bring inflation data for the US and UK.

Given the heightened concerns over high yields, they will be key for associated markets.

UK CPI is expected to stay steady at 2.6%, which is above the BoE’s 2% target but stability would be a positive.

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As usual, services inflation will be the key data point as it has stayed in the 5% region and is a hurdle to any BoE rate cuts.

Paradoxically, a higher inflation reading may actually be a negative for the pound.

“While sterling generally appreciates on inflation surprises, its current indirect correlation with rates means the risks are definitely skewed to the downside.

We must remember that the rise in borrowing costs is eroding the UK Government’s fiscal headroom and incrementally raising the risk of Spring spending cuts – which are, incidentally, negative for sterling,” continue ING.

GBPUSD could trade down to 1.2 by the end of the month.

This content was originally published on ExchangeRates.org.uk

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