Chart of the Week: Sterling slides on domestic weakness, triple-A downgrade-UK Economy
The British pound fell below $1.50 for the first time since 2010 last Friday one week after Moody’s stripped the UK government of its prized triple-A credit rating. Sterling has had a torrid 2013, as investors have sold sterling on the back of domestic weaknesses, stubbornly high inflation and a still-large fiscal deficit. Absent a severe renewal in the Euro Area debt crisis, there is little reason to suspect that a meaningful turnaround is on the horizon.
The credit rating agency, Moody’s, downgraded the UK sovereign from Aaa to Aa1, citing concerns that a weak medium-term growth outlook would hamper the government’s attempts at deficit reduction. There was little new for well-informed investors in the accompanying report, meaning the reaction was always going to be concentrated more among politicians than investors. The opposition Labour party were quick to label the downgrade a ‘humiliation’ for the government. Meanwhile, Prime-Minister, David Cameron, who has staked his reputation on bringing down government borrowing, said he would go ‘further and faster’ in reducing the deficit.
There had been a growing realisation in recent months that the UK was likely to suffer a downgrade. Indeed, Fathom’s own Sovereign Fragility Index, a proprietary measure of a country’s fiscal health, has had the UK in downgrade territory since early 2010. Nevertheless, Moody’s announcement drew attention to the UK economy’s fundamental weaknesses, which include: a large fiscal deficit; a weak medium-term growth outlook; and stubbornly high inflation. Many investors will have seen it as another reason to sell the pound.
Sterling has been on a downward trajectory since the beginning of the year, falling by around 7% against the dollar, and more than 5% on an effective basis. February’s downbeat manufacturing PMI reading hastened the sell-off. Markets had expected a small rise to 51.0, and were spooked by the surprise fall to 47.9. The figure was below the 50 threshold that separates contraction from expansion, raising the spectre of an unprecedented triple-dip recession in the first quarter. Nervous investors sold sterling, pushing it to below 1.50 against the US dollar for the first time since 2010.
There is little reason to suspect sterling’s weakness will unwind any time soon. Inflation is expected to remain sticky, and above target, for the next two years. Meanwhile unresolved weakness in the domestic economy effectively rules out any tightening of monetary policy. If anything, the Bank of England is likely to provide further accommodation. Those who hope this will lead to the oft-mentioned ‘rebalancing’ of the UK economy may end up disappointed. Sterling has fallen by 25% since 2007 with almost nothing to show for it in the way of export-led growth.