Sterling falls again as turmoil dogs the bond market
The pound fell for a fifth day today as the turmoil engulfing UK government bond markets forced the Bank of England to step in yet again to attempt to stem a damaging sell-off in the country’s debt.
Sterling fell 0.3% to $1.1036, and was also down 0.3% against the euro at 88 pence.
The Bank of England said it would extend a series of planned debt buybacks to include inflation-linked bonds – predominantly owned by pension funds – which witnessed their biggest rout on record on Monday.
The bank had already said it would double the amount of long-dated gilts it was willing to buy to ensure a smooth end to its emergency buyback programme that wraps up on Friday.
The Bank of England’s latest intervention helped shore up index-linked gilt prices.
But it had little impact on the pound, which is more heavily influenced by monetary policy and, right now, by the strength of the dollar.
“Sterling is, to an extent, divorced from it. If you have a look at the population of holders of long-dated UK assets – anything that is 15-20 years – it’s mostly domestic funds,” ADM Investor Services Chief Economist Marc Ostwald said.
That said, investors have ditched their exposure to the pound in the last couple of weeks.
Weekly data on Friday showed speculators took an axe to their bets on the pound, given the market’s extreme volatility.
One-week sterling volatility is trading at almost 20%, and while down somewhat from the spike to almost 30% in the wake of the government’s mini-budget, it is still well above the average of closer to 8% that has prevailed over the last five years, according to Refinitiv data.
The pound hit a record low of $1.0327 on September 26.
It has since recovered around 7% in value, but is still showing an 18% loss so far this year – its weakest annual performance against the dollar since 2008.
UK finance minister Kwasi Kwarteng
On September 23, British finance minister Kwasi Kwarteng unveiled a package of unfunded tax cuts worth around £45 billion, including breaks for top earners. The pound promptly nosedived and the gilts money market went into a tailspin, putting pension funds at risk of insolvency.
Gilt yields Soared to their highest in years, prompting the Bank of England to step in to buy long-dated bonds.
Kwarteng has since scrapped the plans to abolish the top rate of tax and brought forward the date he will detail his other plans.
But sterling’s problems extend beyond the liquidity crunch in the gilts market.
The British economy is buckling under the weight of almost double-digit inflation and is expected to tilt into recession this year due to the effects of a cost-of-living crisis, sky-high energy bills and the drag of Brexit.
“If the government fails to fully restore investor confidence quickly, the likelihood of another sharp sell-off for the pound will increase,” MUFG strategist Lee Hardman said.
Data today showed UK unemployment fell to its lowest since 1974, at 3.5% in the three months to August, but this was driven by a record jump in the number of people leaving the labour market.
Average weekly earnings excluding bonuses rose at a rate of 5.4% in the three months to August, but with consumer inflation running at 9.9%, worker pay is not keeping pace.
“The real battle remains against inflation, however the sharp decline in the pound in the past month against the US dollar has done enormous damage to that battle given that we were at $1.1600 this time a month ago and are now well below that,” CMC chief markets strategist Michael Hewson said.