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U.K. Economy is Weakening and The Pound is Reaching Lower

In: Finance, Forex

The British Pound was on track to finish the week sharply lower against the U.S. dollar on Friday, pressured by weak UK economic data, soaring U.S. bond yields and some risk-off sentiment. During New York afternoon market hours, GBP/USD was down 1.44% to 1.2840 on the day and off 1.68% over the past five sessions, trading at lows not seen since September 2020.

Various UK reports on Friday morning, including retail sales, manufacturing output and services sector activity for March, surprised on the downside, a sign that the recovery is faltering and that the economy is starting the second quarter on a weaker footing as surging price pressures curtail demand.

With growth slowing rapidly, the Bank of England (BoE) may not be as aggressive as other central banks in its fight against inflation. This means that we may only see moderate interest rate increases in the coming months, rather than front-loaded hikes such as those entertained by the Federal Reserve, which is now seen raising borrowing costs by 50 bps at its meetings in May, June and possibly July.

Hawkish repricing of Fed policy has pushed the U.S. 2-year yield up 128 bps to 2.72% since March. The 2-year gilt has also drifted upwards, climbing 66 bps to 1.70% over the same period, but its advance has been more limited, a situation that has widened the rate differential enjoyed by the United States.

Looking ahead, there is little reason to be optimistic about sterling. The increasing probability that the UK economy will contract in the second quarter and that the BoE’s normalization cycle will underwhelm expectations may keep GBP/USD subdued or prompt the next leg lower in the exchange rate.

Another variable that may undermine the British pound in the near term and other high-beta currencies for that matter is deteriorating sentiment.

In recent days, market volatility has been on the rise as stocks have plunged across the board. If vols (volatility) levels climb further and equities extend their sell-off, demand for safe haven assets are likely to increase, boosting king U.S. dollar.

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