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LONDON: The pound just can’t catch a break as the United Kingdom’s bleak economic outlook eclipses any benefit the currency stands to receive from rapidly rising interest rates.
Another record inflation readout this week spurred money-market traders to bet the Bank of England (BoE) will more than double its key rate to 3.75% by March from 1.75% currently.
Rather than buy sterling though, investors sold it, while options traders stayed resolutely bearish on the currency versus the US dollar.
They also piled into hedges against higher consumer prices, betting the worst is still to come.
In theory, raising rates should act as a tailwind for currencies and a headwind for bonds.
But in the UK the poor growth outlook, price pressures and uncertainty over the path of policy under a new leader are denting demand for the pound and bonds at the same time.
Sterling has dropped against both the euro and the dollar so far this month, even as the rise in UK bond yields outstrips other markets.
“If this trend persists then it could be truly alarming,” said Mike Riddell, portfolio manager at Allianz Global Investors.,
Global investors probably “don’t like the UK’s double-digit inflation combined with the inflammatory prospect of the likely next prime minister throwing fiscal stimulus on top,” he said.
It’s a dynamic that Adam Cole, currency strategist at RBC Capital Markets, has also spotted. This kind of breakdown in the correlation between currency and yield shifts is typically associated with emerging-market currencies, suggesting investors are questioning the credibility of UK policy, he said.
Cable was trading around US$1.18 (RM5.28) on Friday, on track for its worst weekly performance since September 2020.
The fear-greed indicator, a gauge of momentum that compares buying to selling strength, implies sellers are now controlling prices once again.
The UK currency has also dropped to its lowest level against the euro in almost a month.
Part of the issue is that the UK’s cost of living crisis may restrict the extent to which the BoE can hike despite soaring inflation.
Protests and strikes are already widespread as workers push for higher wages.
One-year inflation swaps, which indicate traders’ bets on the level of the retail price index over the next year, surged past 11.5% after jumping 295 basis points since Tuesday’s close, prior to July’s inflation print.
Trading volumes also jumped: one and two-year gross notional volumes were about six and nine times higher than usual, respectively, according to data compiled by Barclays Plc.