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  • Tuesday 2 August 2022

    How Doomed Is the Pound Sterling?

    Today, the GBPUSD fell below 1.19 support a second time since last week, setting a fresh two-year low. These lows are partly attributable to the USD's strength after Friday's good Non-Farm Payroll data showed over 100,000 more US jobs were created than anticipated; as traders eagerly await Wednesday's new CPI readings, optimism for soaring US inflation builds. The UK economy is currently experiencing extraordinary, negative circumstances, which are largely to blame for the GBPUSD's bearish momentum. We'll examine these factors as we sound the alarm and ask: How doomed is the pound sterling?

    1) Departures and Other Chaos

    Boris Johnson, the leader of the Conservative Party, resigned on July 7, a Thursday morning. Due to dissatisfaction with the party leadership over a number of scandals, over fifty Conservative members of parliament (MPs) unexpectedly resigned at the same time as him. It is important to note that even though Johnson has stepped down as party leader, he still plans to serve as prime minister for the foreseeable future until the ruling Conservative Party chooses a successor. These incidents have contributed to the instability in Parliament and won't change how well it solves economic problems or how people feel about it.

    Political resignations of this magnitude would be disruptive for any nation, but the UK is particularly affected since post-Brexit trade agreements are either in the early stages of development or have not yet been completed. Trade figures have been unstable and challenging to interpret since 2020, when Brexit went into force, and the UK's trade to GDP ratio decreased by 8.31 percent (from 63.4 percent to 55.09 percent). This is especially true in light of post-COVID supply chain issues. "It continues to be difficult to identify the extent to which trade fluctuations represent short-term trade interruption or longer-term supply chain modifications," the UK's Office for National Statistics stated.

    2) The Bank of England Is Unwilling

    The UK experienced the highest annual inflation rate of the G7 nations in May, hitting a startling 9.1 percent. Higher inflation indicates an expanding economy and is a precursor to rate increases, which are measures by the central bank to stabilize prices, therefore this should be beneficial for the pound. The UK's central bank, the Bank of England (BoE), has warned that annual inflation may reach 11% in the near future, yet they behind the US Federal Reserve in terms of hawkish aggressiveness by a wide margin. With their target interest rate currently at 1.25 percent, they have only raised rates by 25 basis points in the past year, which is about as mild as tightening monetary policy can be.

    3)The Unemployment Rate Is Increasing

    Recently, the jobless rate in the UK increased to 3.8 percent. Even though rising unemployment is a terrible indicator for the health of any nation's economy, the UK and the Bank of England are particularly troubled by this for two reasons. First, with inflation at 40-year highs and the BoE's target interest rate at a relatively low 1.25 percent, This suggests that the labor market and, consequently, the economy of the UK are fragile, which perhaps explains the BoE's caution over unconventional monetary policy. Second, rising unemployment may particularly help to limit consumer spending if the UK labor market remains keenly sensitive to a cooling economy, which would lessen the overall need for BoE intervention through rate hikes (unless stagflation surfaces).

    4) Negative Institutional Attitude

    GBP is the third most shorted COT asset, with 70.75 percent of all institutional traders selling the Pound, according to latest Commitments of Traders (COT) data. Given that a large portion of the currency market action is driven by institutional activity due to the sheer magnitude of their buying and sales, this bearishness is a key component in producing GBP selling pressure.

    What Takes Place Next?

    Despite strong inflation, the fundamentals for the GBP currently seem quite grim, and this is reflected in the COT statistics. But there's a potential that the UK's hyperinflation will finally force the BoE's hand and cause them to shift toward hawkishness in order to avoid a catastrophic overheating. Although this pivot and fresh GBP positive momentum may be approaching, traders would be advised to wait until the BoE gives unambiguous indications before making this assumption. If not, it appears that GBP will continue to decline.

    Main Points

    GBPUSD experienced another intraday two-year low due to persistent selling pressure.

    Following Prime Minister Boris Johnson's resignation as leader of the ruling Conservative Party amid a wave of MP resignations, UK leadership remains in chaos. This is hardly encouraging for the UK economy or future trade negotiations after Brexit.

    The Bank of England (BoE) keeps raising interest rates by 25 basis points at a glacial pace despite the UK's annual inflation rate of 9.1 percent, which is the highest among the G7 nations.

    Despite the BoE's muted hawkishness, the UK's unemployment rate recently rose to 3.8 percent, highlighting a fragile economy that may lead to additional BoE caution.

    With institutional traders selling GBP at a rate of 70.75 percent, the pound is still the third most shorted COT asset. This pessimism makes GBP selling more likely.

    Sifiso Nkwanyana

    Author & Editor

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