The pound recovered after falling to its lowest level in almost two years on Friday. Analysts do not expect the pound to US dollar exchange rate to stage a significant recovery after the Bank of England's grim recession warning on Thursday.
The UK economic outlook has weakened, while global investor sentiment has also deteriorated. Investors have now lowered their expectations for the number of future rate hikes at the BoE which has hurt the British currency.
Global concerns about recession
The global economic outlook is also gloomy as China’s Covid-19 lockdowns, rising inflation and the war in Ukraine are all fuelling recession fears. Mihir Kapadia, CEO of Sun Global Investments, has highlighted fears about supply chains and inflationary pressures, including higher interest rates which are affecting the financial markets. A disruption in supply chains, will hurt companies’ earnings and stocks, while higher inflation, higher interest rates and higher bond yields will undermine asset prices and consequently result in falls in stocks and bonds. As Kapadia noted, “With consumer inflation at an all-time high, along with rising energy prices, the cost-of-living crisis threatens to spill over into a larger recession in Europe and the US.”
Worries about higher interest rates are driving stocks lower, as central banks such as the US Federal Reserve are determined to fight inflation by tightening policy, which has added more pressure on markets.
Markets are also concerned due to the current geopolitical risks as Russian President Vladimir Putin celebrates the Soviet victory against the Nazis in the Second World War. Russia’s display of military strength has created concerns as the threat of nuclear conflict looms in the air.
BoE interest rate expectations
After hiking the policy rate by 25 basis points (bps) to 1%, the BoE noted that the UK economy could go into recession in 2022 with inflation rising above 10% as energy prices continue to rise.
The BoE’s gloomy outlook suggests that the policy divergence between the Fed will possibly widen further, as the Fed will hike its policy rate by 50 bps in the next couple of policy meetings.
Analysts expect further weakness for the pound, but they have noted that the British currency has been oversold and it might get a respite as it recovers for a few days. The slowing economy and the rising cost of living will not provide any support to Sterling though, analysts fear.
The Bank of England warned the UK economy would risk a prolonged recession over coming months if it continued raising interest rates to meet the market's current expectations. The market expects the Bank Rate to go to 2.5% by 2023, but the BoE warned that such a move will result in negative economic growth in 2022 and 2023. Following Thursday’s BoE meeting, the market has now been forced to lower its expectations and this have weighed on Sterling.
With inflation rising in the UK, economists explained that the extent of the economic slowdown will depend on households starting to spend their savings, and the strength of nominal wage growth.
The war in Ukraine continues and global market sentiment will remain weak, as energy and commodity costs rise driving inflation higher. The Fed’s determination to hike rates will also weigh on global growth, while China’s zero-covid approach with strict lockdowns will hurt its economy and global growth, sparking further concerns. All these worries are also pushing the pound lower.
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