BlueBay Shuns Pound as Economic Gloom Casts Doubt on Rate Hikes
The pound is falling out of favor as gloom over the U.K. economy sows doubt that the Bank of England can deliver the rate hikes that traders expect.
BlueBay Asset Management LLP and Nomura International Plc turned bearish on the pound this week, while Deutsche Bank AG slashed its year-end forecast. That’s despite heightened expectations for policy tightening next year, which drove two-year bond yields to the highest since the start of the coronavirus pandemic.
Soaring energy prices, fears over inflation and the end of the government’s furlough program are drowning out the benefits of the central bank’s hawkish outlook, which would normally strengthen a country’s currency. It’s enough to prompt BlueBay to shift its position on the currency to short from neutral according to Mark Dowding, who oversees $70 billion at the firm.
“U.K. inflation could rise to 6% in the New Year on the back of soaring utility bills and other costs,” said Dowding, who foresees a 10% decline in the currency over the next six months if the phenomenon of high inflation and slow growth takes root. “Consequently, the BOE could become rabbits in the headlights. The BOE sounds hawkish but it may need to flip flop if growth disappoints.”
Options traders too are losing confidence, with one-month risk reversals -- a gauge of positioning in the currency -- indicating the most bearish sentiment in six months. Meanwhile, the cost of hedging turbulence in the pound over the next week is near the highest since March.
Price action in sterling marked a stark contrast with U.K. two-year yields, which climbed this week to 0.47%, the highest since March 2020. The yields soared as traders priced rate increases of as much as 65 basis points for 2022, which would take the BOE’s key rate to 0.75% by December of next year. That’s in response to policy makers opening the door to an adjustment as soon as November, in minutes of their meeting last month.
Nomura International Plc strategists are skeptical that bets on policy tightening would lift the pound. Instead, they expect around a 3% dip to $1.3150 -- a level last seen in December -- over the next month.
“The usual playbook of ‘BOE to raise rates equals strong pound’ isn’t going to happen,” Nomura’s Jordan Rochester said. “We’ve switched to being more focused on inflation expectations, and already there is a lot priced into the BOE.”
The pound has fallen 2% over the past six months, underperforming all Group-of-10 peers except the Australian dollar.
Against the backdrop of fresh complications arising from Brexit, rising wages and the possibility of an increase in national insurance tax next year, some are reconsidering the benefits of any potential rate hikes.
“The prospect of BOE tightening could be seen as a policy mistake,” said Jane Foley, head of foreign-exchange strategy at Rabobank. “The weight of negative fundamentals in the U.K. has driven a wedge between the pound and rates.”
- European government bond supply will rise to 22 billion euros next week from around 19 billion euros, according to Commerzbank, with sales in Germany, Austria, France and Spain
- BOE’s Ramsden speaks on Monday -- having dissented at the last MPC decision -- and ECB’s Lagarde on Tuesday
- Lane and Schnabel also make addresses at the joint ECB and Federal Reserve Bank of Cleveland conference on Thursday
- On the data front, the highlights are Germany factory orders due Wednesday and European and U.K. PMI data on Tuesday
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