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Sterling almost erases losses following UK government’s mini-Budget

Pound is still down 9 per cent in the past three months

Sterling regained much of its losses recorded against the dollar in the past week (Photo by DANIEL LEAL/AFP via Getty Images)

Fri Sep 30 2022 - 12:42

Sterling on Friday hit its highest level against the dollar since UK chancellor Kwasi Kwarteng delivered the his so-called mini-budget a week ago.

The pound rose as much as 1.1 per cent to $1.1234 in morning dealings, almost erasing its losses from a steep sell-off this week sparked by concerns over the £45 billion debt-financed tax-cutting package in the UK.

Sterling pared its gains later in morning trading at $1.11, down 0.3 per cent, still stronger than its depths earlier in the week.

The moves on Friday came as Mr Kwarteng and Prime Minister Liz Truss met officials at the Office for Budget Responsibility (OBR), the independent forecaster. Securing costings for the new fiscal plans is seen in financial markets as essential to restoring the government’s economic credibility.

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“The [Bank of England’s] actions in the gilt markets and the OBR coming forward with a more timely assessment of the economic forecasts have given markets a short-term confidence boost,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore.

However, the brief rebound still left sterling down 9 per cent over the past three months, its worst quarter since the 2008 financial crisis. Reaction to the UK’s new fiscal plans sent the pound to a record low of $1.035 against the dollar this week.

The strength of the US dollar, as investors seek a haven from falling stock and bond prices — and as the US Federal Reserve raises interest rates aggressively — has added to the UK currency’s woes. The dollar advanced 0.4 per cent on Friday, against a basket of six other currencies.

“When everything is underperforming the natural place to park is US dollar cash,” said Adam Cole, head of foreign exchange strategy at RBC Capital Markets. “At the root of all of those moves is tighter monetary policy but it’s playing out in slightly unusual ways.”

The outlook for the UK currency remains gloomy, Cole said, as Mr Kwarteng’s budget had only highlighted underlying economic issues that were weighing down on sterling.

“I think what last Friday did was throw a very bright spotlight on some issues that we were already worried about, namely the macroeconomic imbalances in the UK,” he said.

Analysts warned that a negative assessment from the OBR or a clash between the independent forecaster and the government could deliver a fresh knock to sterling.

“It would be damaging if the OBR publish a serious forecast and the government takes issue with the growth assumption,” said Cole.

Weakness in sterling has sparked speculation that the currency could hit parity with the US dollar.

Paul Grainger, head of global fixed income and currency at Schroders, said: “The loss of confidence and unfunded nature of the [fiscal] plan have caused sterling to sell off significantly. Many market commentators are calling for it to go to parity, or lower, against the US dollar.”

Mr Mohi-uddin said that the “bigger worry is that the underlying fundamentals haven’t changed”, adding that if the government sticks to its plan, the Bank of England will be forced to undertake a large rate increase in November. “Otherwise we’ll start seeing more turbulence for sterling.” — Copyright The Financial Times Limited 2022

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