Sterling has rallied 10% since touching all-time lows versus the dollar at the beginning of last week. In that time, it has been called many things, with one of the most common themes being it is like an emerging market currency. Trading conditions and volatile swings in exchange rates make it a better match with the Mexican peso than the US dollar said one prominent investment bank. The key question for traders is whether the move higher can last?
Traditionally, sterling has been one of the most heavily traded and safest major currencies in the world. There’s no doubt that GBP implied volatility, a gauge of investors’ expectations of the scale of future price moves, has surged recently, to the highest levels since March 2020. But this volatility has eased as the government has U-turned on its top tax rate while the BoE intervention has stemmed rampant bond yields in gilts.
“We get it, and we have listened”
After only a few weeks in power, the new Chancellor and Prime Minister have realised that, along with a revolting party, markets will react immediately if they can smell blood. Of course, that effect works both ways which means any more major U-turns will result in continued support for GBP. The decision to bring forward the medium-term fiscal plan this month, which was previously set for release in late November, is another case in point. Markets had also been unimpressed by the government’s refusal to engage with the Office for Budget Responsibility.
Sterling drivers
It's really all about credibility and the ability of the UK to fund any big fiscal largesse. The top rate of tax policy actually cost the least, amounting to less than 5% of the total measures. So, this doesn’t mean that the market’s worries are now fixed as international investors still remain reluctant to finance the UK’s current account deficit. We wonder if the dumping of this minor measure plays to Tory MPs and emboldens the leadership to proceed more strongly with the rest of the fiscal plan. This would potentially see sterling selling resume.
Ratings agencies will be in focus after S&P Global downgraded the outlook on the UK’s double A credit rating to negative on Friday. The next major review is due on 21 October. Before then, sterling will be at the mercy of fiscal headlines and the PM’s speech tomorrow, while Parliament resumes next week along with the ending of the BoE’s emergency bond-buying program. We note that recent dollar weakness is not expected to continue as we head into Friday’s release of an expected solid US non-farm payrolls report. In the medium term, much depends on how forceful the BoE will be in hiking rates. The bank is expected to hike by 75bps at its next meeting at the start of next month. But it has failed to keep pace with the aggressive tightening path of the Fed, which meets the day before.