The British pound will fall below the US dollar by year-end unless the UK government forces a U-turn on its latest tax cut plans, Nomura says
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- The British pound is set to trade below the US dollar by the end of November, according to a note from Nomura.
- The firm said it has high conviction the pound will continue to trend lower following the UK's tax cuts.
- "This is a fundamental balance of payments crisis, with politicians hoping it will eventually just calm down. Hope is not a strategy," Nomura said.
The British pound has been in free-fall over the past week following the UK's decision to implement wide-ranging tax cuts and other fiscal stimulus measures at a time when inflation is still running hot.
The pound fell to a record low against the US dollar over the weekend, and strategists at Nomura expect the downtrend to continue into early next-year.
In a Monday note, Nomura said it expects the pound to reach parity with the dollar by the end of November, and for it to fall to 0.975 relative to the dollar by the end of the year. Additionally, the firm said it expects the pound to hit 0.95 relative to the dollar in the first-quarter of next year.
"This is a fundamental balance of payments crisis, with politicians hoping it will eventually just calm down. Hope is not a strategy, and markets are reflecting that," Nomura said. Specifically, the UK's current account deficit has widened to over 8% of GDP in the first quarter, and it likely hovered around that level through the second-quarter as well.
"This is far worse than in 1974 (the UK was bailed out by the IMF in 1976) or in 1989, when the current account deficit-to-GDP ratio reached troughs of around 4-5%," Nomura explained. In fact, the firm said that the UK's current account deficit could be even wider than 8% given the moves in energy markets since June.
"That is the biggest current account deficit in modern history for the UK, and unlike in 2020, the Bank of England is not conducting quantitative easing to soak up the majority of the fresh issuance. It is therefore not helpful the government added to expected issuance last week," Nomura said.
There is a road to recovery for the pound, according to Nomura, and it's based on three potential catalysts:
1. A surprise rate hike from the Bank of England.
2. Conservative lawmakers force a government U-turn on its fiscal stimulus plans.
3. A further recovery in medium-term global economic growth expectations.
Still, those three potential catalysts don't guarantee a swift recovery in the pound, according to the note. Emergency rate hikes amid lower growth expectations and a potential recession won't help the pound in the short-term, and there's no indication the UK government will force a reversal of its recent fiscal stimulus policy.
"Short [the] British pound and short gilts is a very consensus trade but that doesn't mean it is not the right one to hold from here. None of the above risks to holding pound British pound shorts change the medium-term message from the UK's collapsing terms of trade," Nomura said.
Contributer : Business Insider https://ift.tt/LXqHJhk
Reviewed by mimisabreena
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Tuesday, September 27, 2022
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