By Mike Dolan
LONDON (Reuters) – The pound is once again taking heat as UK financial markets move – often a sign of stress in a country that relies heavily on foreign funding, but also ' could be a safety valve to solve the problem.
The alarming New Year's spike in British government bonds is largely due to a sharp rise in global sovereign borrowing costs, with a yield hike by the US Treasury ahead of the incoming Donald Trump administration as a key a mover.
In fact, the spreads between British 'gilt' yields and the equivalent 10-year and 30-year bonds have barely narrowed over the past three months.
However, the nominal 30-year gilt yield this week hit its highest level in more than 25 years, while the 10-year yield rose back to 2008 levels. This creates all kinds of a headache for the new Labor government, which is already struggling to deliver its pro-growth agenda and taking a hit from the poor reception of the tax and spending budget which was published in October.
And in a surprising twist, the pound suddenly stopped following higher gilt yields this week, as it had for much of the past year, and went in the opposite direction instead.
Just a month ago, the pound sailed to its highest level against the euro since 2016, after setting a similar milestone on the broader trade index in November.
Why the sudden opposition – one that surely recalls the 2022 budget debate under former Tory Prime Minister Liz Truss?
Nothing seismic has changed on the UK's domestic economic front in recent weeks to warrant this move, even if many have been taken aback by reports this week of billionaire Trump adviser Elon Musk which aims to expel the UK Prime Minister.
As late as December, many market players had been taking up big positions, encouraged by the relatively tight policy stance of the Bank of England compared to the rest of Europe and a perception that the UK was better off the euro zone to resist the global situation promoted by Trump. trade war.
And while the net speculative position had fallen from its mid-year highs, it remained positive until the end of the year against a very strong dollar.
Simple answer?
But now many of these positions are being rapidly terminated, apparently based on the belief that Britain's borrowing costs cannot continue to rise above US Treasury yields without the UK ' take a big economic and budgetary hit.
Unlike the dynamic US economy, the UK is arguably much less able to absorb this pain.
But is this a crisis?
There is still no sign of wider debt market movements, such as those seen in 2022, and although note volatility has increased, it is still half of what it was then.
However, a problem that originates from abroad can be worse than a domestic problem, simply because the government has little power to solve it.
And the combination of falling sterling and rising gilt yields is a red flag.
For some this is an old UK problem, perhaps exacerbated by the country's departure from the European Union and the isolation of its relatively small open economy. Its large current account and capital flow deficits make it more vulnerable than other major economies to shifts in global financial conditions and market-based funding costs in particular.
Deutsche Bank (ETR 🙂 Chief currency strategist George Saravelos identified the shortfall in payments in Britain long ago with the rest of the world as the speaker of this story.
“The more a country relies on foreign finance to service its domestic debt, the more exposed it is to the global environment,” he told clients on Thursday. “From the perspective of external flows, the UK is one of the most vulnerable in the G10.”
So what is the solution?
“The answer is simple: a weaker currency,” according to Saravelos, adding that this helps the country's investment situation because if UK assets become cheaper for foreign investors, this should attract capital and help reduce the current account gap.
The pound may have to fall further, he believes, but the reversal is likely to be a “natural balancing process” rather than a spiral or crisis.
That seems like a rather rude view of the week's resolutions. Others believe these rumors reflect the UK's continued inflation and weak growth exacerbated by recent income tax increases. Some worry that a sharp blow of sterling weakness could reignite inflation and tie the BoE's hands further.
Either way, it looks like sterling's time in the sun is over for now. But this fall from grace may be what is needed to solve the problem and attract foreign investors back to higher-yielding gilts.
The views expressed here are those of the author, a columnist for Reuters.
(by Mike Dolan; Editing by Sonali Paul)
