The pound’s rally early Friday saw it briefly erase all of the losses it made since Kwasi Kwarteng began his speech last Friday announcing sweeping UK tax cut.

Sterling has gained more than 7% from its all-time low of $1.0350 set early Monday, climbing to as high as to $1.12 in early Asian trade, about where it was before the Chancellor of the Exchequer began speaking in parliament about the mini-budget almost a week ago. The Bank of England’s bond purchases and the stabilization of gilts yields were a big factor in soothing fears, strategists say.  

“It’s a reminder that currencies are driven by a myriad of factors -- it’s clearly not due to any improvement in the outlook for the UK,” said Sean Callow, strategist at Westpac Banking Corp. in Sydney. “The pound does at least have much stronger yield support now. Loose fiscal policy is often supportive for currencies to the extent that it can force tighter monetary policy.”

Money markets are pricing in about 140 basis points of tightening at the central bank’s next meeting in November, a super-sized rate hike that will further underpin the pound.

Pound’s Tumble

Sterling closed 3.6% lower last Friday as markets digested the reduction of levies on rich households and companies in a bid to boost economic growth. The currency then slumped as much as 4.7% in early Monday trading amid concern the proposals estimated at about £161 billion ($179 billion) over a five-year period would lead to faster inflation and a spiraling government debt burden.

The pound traded at $1.1092 about 11:20 a.m. in Singapore, still down almost 18% this year.

The BOE stepped in to offer support on Wednesday, pledging unlimited purchases of longer-maturity bonds, after the selloff threatened to push the gilt market into a downward spiral and spark a pension-fund crisis.

Sterling’s rebound may also have been driven by speculation a collapse in political support for Prime Minister Liz Truss will compel her and the chancellor to abandon their projected tax cuts.

Groups of Tory lawmakers have spent two days in frantic discussions following the BOE intervention. Some have privately called on Kwarteng to quit less than a month into the job to give Truss political cover to reverse plans for unfunded tax cuts that have roiled investors.

“Truss may not necessarily be kicked out -- just forced with Kwarteng to make a complete U-turn on last week’s tax cut plans,” said Ray Attrill, strategist at National Australia Bank Ltd. in Sydney.

Bears Remain

Despite the currency’s recovery this week, many in the market remain bearish.

Nomura Holdings Inc. projects sterling will fall to 98 cents by year-end, while Morgan Stanley and TD Securities see it sliding to parity over the same period, according to analyst forecasts compiled by Bloomberg. The probability that it will fall to parity this year is currently about 23%, option-market pricing shows.

“The pound is not out of the woods yet,” said David Forrester, a strategist at Credit Agricole CIB in Hong Kong. “While the BOE has restored some credibility to the currency, the government’s finances are another part that needs to be fixed for the pound’s rally to last.”

Source:
courtesy of BLOOMBERG

by Ruth Carson and Matthew Burgess

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