Fundamental analysis

Pound – the weather vane of the British stock market – imagined itself as a rocket, which is cramped in the financial galaxy

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After the victory of Rishi Sunak, the new prime minister of Great Britain, the national currency went up, reacting positively to changes in the government. At this time, many treated the pound as a kind of talisman that helps the growth of the financial market and the new prime minister of Great Britain. However, for the majority, sterling is still a weather vane of market sentiment, and not a locomotive.

According to economists, the markets fully appreciated Sunak’s victory, to which the pound reacted with a confident growth. Sterling was strongly supported by improved risk appetite. However, many analysts are worried about the structural imbalance in the UK economy, which remains a long-term problem for the national currency. Recall that the structural deficit of the British budget reaches 6% of GDP and is one of the largest among developed countries. At the same time, the UK is completely dependent on foreign capital, which is intended to finance the domestic market. According to experts, Sunak and his team will have to deal with the growing economic crisis and political instability in the country. Currency strategists at CIBC believe that the current uncertainty in the UK will continue in the near future.

Against this background, market participants are worried about the medium-term and long-term dynamics of the pound. Investors and traders fear its further decline against the US currency. Earlier, the dollar showed strengthening, which slowed down a bit due to the aggressive tightening of the Federal Reserve’s monetary policy. As for the euro, it stabilized ahead of the European Central Bank meeting scheduled for Thursday, October 27th. According to preliminary forecasts, the central bank will again raise the key rate there to cope with the energy crisis and rising inflation.

Sunak’s victory contributed to the pound’s growth, but experts warn against excessive euphoria. The GBP/USD pair broke through the 1.1300 level on Tuesday, October 25, and at some point reached an impressive 1.1500. In many ways, this was facilitated by a short-term weakening of the greenback. As a result, the pound gained 1.70%, offsetting the previous losses and testing the peak of this month. The GBP/USD pair broke the previous levels of 1.1400-1.1500 on Wednesday morning, October 26, and soared to a fantastic 1.1553. The rocket-like movement of the pound did not go unnoticed, causing delight and surprise in the market.

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The positive mood of traders and investors was promoted not only by Sunak’s victory, but also by his promise to restore economic stability in the country. The confidence of traders and investors also caused the decision to reappoint Treasury Secretary Jeremy Hunt. According to experts, this gave hope for the stabilization and growth of the market and became a tailwind for the British currency.

However, some analysts are far from optimistic. Currency strategists at Wells Fargo expect a significant weakening of the pound. The specialists believe that by the beginning of 2023 the GBP/USD pair will reach a low near 1.0600. Recall that this year the pound fell in relation to the greenback by 16%.

Against this background, experts assume that the Bank of England will take a break in the process of raising the key rate. At the same time, many economists expect the central bank to raise rates by 75 bps at the next meeting, scheduled for November 3. This forecast is in line with market expectations, experts emphasize. According to preliminary calculations, in the first quarter of 2023, the BoE will reach the upper limit of its discount rate (at 4.25%).

According to Charles Hepworth, chief investment officer at GAM Investments, market participants believe that the central bank will have to reduce the intensity of aggression towards the rate hike “since the lid of the fiscal box of gifts has been slammed shut again.” Tax cuts are not expected anytime soon and this is “bad news for UK consumers”. According to a GAM Investments analyst, the British economy is already in a recessionary spiral. The current combination of political uncertainty and the removal of fiscal stimulus have worsened its outlook. Further aggravation of the situation can bring down the pound and weaken the national economy, experts are sure.

Note that a slight decrease in GBP was recorded after the appeal of the new prime minister to Parliament. Sunak warned about the upcoming difficulties for the British economy, which primarily relate to public funding. However, the economic downturn risks worsening in the coming months if the new government continues its spending cuts. Recall that these measures were implemented as part of a plan to balance the national budget.

According to calculations by Rabobank analysts, the implementation of the government’s medium-term financial plan is unlikely to provide significant support to the pound. The plan of the British authorities, expected next Monday, October 31, will include tax increases and spending cuts. According to Jane Foley, currency strategist at Rabobank, such a policy would “further undermine the country’s economic growth prospects.” Analysts at ING Bank also pin UK financial hopes on the upcoming plan, stressing that October 31st will be “another big day for the country’s financial markets.” According to Foley, the implementation of the Sunak-Hunt plan will bring order to the chaos in the debt securities market and reduce the risk of panic sales of the pound.

However, in the long term, the consequences of this initiative may not be as positive for the GBP as previously expected. The instability of the fundamental background of the UK suggests that in the coming months the sterling will fall against the dollar, emphasizes Foley. At the same time, analysts at Rabobank, as well as currency strategists at Wells Fargo, expect that the GBP/USD pair will drop to 1.0600 on the horizon of three months.

According to experts, it is very important for traders and investors to know the details of the new Sunak-Hunt financial plan. According to analysts, the change in the UK government has reduced the risk of the GBP/USD pair collapsing, although the current economic conditions still point in favor of the pound’s weakening. Currency strategists at UBS Global Wealth Management are confident that sterling will trade near 1.1000 in the near future. This goal for the GBP/USD pair by the end of 2022 is also indicated by ING bank analysts. At the same time, the specialists believe that in the short and medium term, the pound will remain in the range of 1.1500-1.1600, aiming for the level of 1.1700.

The material has been provided by InstaForex Company – www.instaforex.com


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