Why sterling's bounce was so tepid — Boris Johnson's replacement faces an economy at risk of recession

Why sterling’s bounce was so tepid — Boris Johnson’s replacement faces an economy at risk of recession

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The political uncertainty is, if not over, at least reduced: U.K. Prime Minister Boris Johnson announced he is resigning.

The pound

did rise, moving to as high as $1.2024 from $1.1926 on Wednesday. The U.K. currency

also advanced versus the euro.

“A quick resolution to the political impasse would mean policy varying less and no additional fiscal stimulus over the next few months. Moreover, the chances of having greater clarity on Brexit policy and lower budget stress improve,” said Gabriele Foa, co-portfolio manager at Algebris Investments.

But that’s not much given the pound has dropped 11% this year.

Part of the reason has to do with the remaining uncertainty and the internal Conservative battle for who will be the next prime minister. There also will be the question of whether a general election will be called ahead of 2024, when one must be carried out.

There’s also a weak economic backdrop, the possibility of a Northern Ireland move that could further rupture the trade relationship with the European Union and a Bank of England rate-hike campaign.

“The pound remains severely weak due to the dire state of the U.K. economy which is underperforming its peers, likely to enter into a recession while the Bank of England refuses to hike interest rates aggressively to deal with the escalating inflation,” said Walid Koudmani, chief market analyst at XTB.

The current inflation rate of 9.1% is well above the Bank of England’s 2% target, and the Bank of England says it expects inflation to rise to 11% in October. At the same time, the U.K. economy is expected to fall at a 0.3% quarterly rate in the second quarter, the central bank projects. The Bank of England has raised rates from 0.1% to 1.25%, but done so in a way that has projected a less-hawkish image than some of its international rivals.

Economists at Goldman Sachs assign a higher probability the U.K. will enter recession next year, 45%, than in the euro area or the U.S.

“Boris Johnson’s resignation does little to change the macroeconomic reality for the U.K. or the market reality for the pound, where the toxic mix of rising household costs, particularly domestic energy costs, and slowing growth look likely to test any future leader,” said TIm Graf, head of EMEA macro strategy at State Street.

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