The pound registered its biggest monthly decline against the dollar since the day after the Brexit referendum amid growing economic and political uncertainty.
The pound fell 4.5% in August to $1.16, the biggest monthly drop since October 2016. The pound was also down nearly 3% against the euro.
The fall in the currency reflects the deteriorating outlook for the UK economy as the energy crisis deals a powerful blow to businesses and consumers. The new prime minister, who is due to be appointed next week, could bring further uncertainty as he sets new budget priorities.
“Cyclical crosswinds are set to intensify for the pound in the fall as the UK economy navigates new fiscal initiatives against continued rises in energy costs and the consumer price index” , JPMorgan analysts said earlier this month.
Liz Truss, favorite to win the Tory leadership contest, has pledged to offer £30billion in tax cuts as part of a plan to bolster Britain’s economy against worsening coronavirus cost of living crisis.
Economists say an easing in fiscal policy could ease the recession predicted by the Bank of England and many City economists to start later this year. However, some analysts said a stimulus of this nature could make it harder for the BoE to fight off the worst bout of inflation in more than 40 years.
Philip Shaw, chief economist at Investec in London, said the rapid fall in the pound was “very worrying” as it reflected fears that if Truss were appointed prime minister, his government’s policies would diverge from those of the BoE . UK government bonds also sold off this month more aggressively than the debt of other major European peers such as Germany.
George Saravelos, global head of FX research at Deutsche Bank, said investors were right to question whether the UK’s fiscal and monetary mix was appropriate and how it would affect inflation.
“Price pressures are becoming persistent and spreading. But what kind of signal is the UK government sending about inflation? Saravelos said, adding that the BoE has not been as aggressive or effective in its inflation risk communications as the US Federal Reserve or the European Central Bank.
Saravelos said the reaction of foreign exchange markets to aggressive unfunded tax promises or a large-scale VAT cut would likely be less favorable than aid on energy bills targeted at affected income groups.
The pound was also dragged lower by a broad rise in the US dollar this month, with traders betting that the Fed will continue a strategy of aggressive rate hikes in the months ahead. But the pound’s fall in August was more severe than any of the G10 currencies except the Swedish krona.
There are tentative signs that the pressure on the currency may ease. Speculators, including funds that trade in currency derivatives, have reduced their bearish bets against the pound in recent weeks. The group now holds a net short futures position of 27,966 contracts, down from a recent high of 80,372 at the end of May, according to Commodity Futures Trading Commission data compiled by Bloomberg.
“Leverage funds are not aggressively short against [sterling]said Stephen Gallo, European Head of FX Strategy at BMO Capital Markets. “Other fund managers – the asset allocators – are reducing their sterling hedges, suggesting they are reducing their exposure to UK assets. But it is unclear if these recent moves are driven by flows. short-term portfolio changes or by changes in longer-term foreign direct investment flows.
Large international investors reduced their exposure to the UK stock market in July, with 15% of global fund managers reporting an “underweight” position in UK stocks, down 11 percentage points from the previous month’s position, according to Bank of America, which surveyed the opinions of 250 respondents with combined assets of $752 billion.