MacroResearchBoard

U.K. Pound: Between A Rock And A Hard Place – July 3, 2023

A just-published report updated our view on global financial markets and examined a number of timely investment issues. The U.K. pound was the focus in one section, and we re-iterated our underweight recommendation versus both the U.S. dollar and euro.

The pound remains weighed down by structural drags and failed to benefit from the BoE’s larger-than-expected 50 bps rate hike two weeks ago. The BoE faces a difficult choice, does it:

• Protect the domestic economy, and especially the interest-rate sensitive household sector, by holding back from boosting policy rates further?
• Or does it keep lifting interest rates to resolve a bigger inflation problem than exists in the other major DM economies, thereby risking debt deflation (in view of the country’s massive indebtedness)?

Taking the first option would eventually force the BoE onto the second pathway because inflation has become entrenched and most likely will not return to low levels absent a recession. To this end, unlike other DM economies, the U.K.’s core CPI rate has actually risen in recent months. The BoE will try to find a middle ground in the coming months, but there is little room to maneuver and the pound is likely to suffer as a consequence.