By Nick Hedley
The U.K.’s economic and political crises are increasing the risk of a “collapse” in the value of the British pound, which could move close to parity with the dollar, according to Bank of Singapore’s chief economist, Mansoor Mohi-uddin.
From trading around $1.37/£ in mid-January, the pound has been steadily weakening as inflation surges, recession fears build, and industrial pay disputes worsen.
On August 26, it was trading at $1.18/£, but Mohi-uddin said it could still slide to levels last seen in the mid-1980s if any further shocks materialize.
“A sudden loss of investor confidence now could see a test of its all-time 1985 low of $1.05,” he said in a research note.
The U.K. is currently grappling with double-digit inflation owing to pandemic disruptions, the gas crisis, and trade frictions linked to Brexit.
According to Bank of England (BoE) forecasts, inflation is set to hit 13% when household energy bills are reset in October. But that could be a conservative estimate if Russia continues to throttle gas supplie, Mohi-uddin said.
Partly because of this, Bank of Singapore expects the U.K.’s economy to shrink 0.6% in 2023.
Mohi-uddin said ongoing disputes over pay increases pose another risk, as does the poor state of public services, including the National Health Service, which have been underfunded in recent years.
Meanwhile, disputes with the EU following Brexit are weighing on trade “and may result in a costlier confrontation over Northern Ireland’s exports.”
Despite these risks, the government “seems paralyzed” as the ruling Conservative Party elects a new leader to replace Prime Minister Boris Johnson.
Bank of Singapore expects another 100 basis points of interest rate increases by the end of the year.
“But interest rate hikes may not be enough to prevent a GBP collapse,” Mohi-uddin said. “For example, the BoE may be forced to pause its tightening by year-end if Russian gas supplies to Europe are fully cut off and the U.K. falls into recession.
“With the U.K. current account deficit at a staggering 8% of GDP, the GBP is highly vulnerable to capital inflows drying up.”
Nicholas Fawcett, vice president of the BlackRock Investment Institute, said in a research note that considering where inflation is now, the level of activity the U.K. economy can comfortably sustain is probably 5-6% lower than it would have been without the pandemic.
For context, that is the equivalent of Manchester, Birmingham and Bristol – three sizeable U.K. cities – no longer producing anything at all.
The U.K.’s production problems stem mainly from a low labor supply, with many firms struggling to fill vacant posts, according to the report, which was co-authored by Alex Brazier, deputy head of the BlackRock Investment Institute.
“The only way to have avoided an inflation problem would have been to choke off the economy’s restart from the pandemic shutdowns much earlier,” Brazier said.
“Having not done that, the Bank of England, like the Federal Reserve, is between a rock and a hard place. It must now either slam economic activity down with a deep recession or live with persistent shortages and broad inflation pressures.”