Leading economists predict pound to reach parity with dollar

Investors ditch sterling as Britain's energy crunch cripples consumer spending

The Bank of England in London. UK inflation has reached a 40-year high. EPA
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Leading economists have predicted that Britain's pound is on course for near parity with the US dollar as inflation and soaring energy prices push the country to the brink of recession.

Sterling has weakened significantly since the start of the year, dropping more than 17 per cent since January to reach its current level. In late trading on Thursday, the pound was down as far as $1.1499, or an on the day loss of more than one per cent.

But some experts are forecasting that the pound could fall as low as $1.05 and then be vulnerable to breaching the 1:1 level by the middle of next year as energy bills more than triple and eat into household spending.

What's causing the pound's weakness?

According to Capital Economics, the continuing energy crunch, largely caused by the war in Ukraine, will tip Britain into a recession by next year.

Paul Dales, chief UK economist at the consultancy, said he believed the markets were already expecting a lengthy recession in Britain, but said the "US may avoid one".

“If anything, the recent surge in UK wholesale gas prices suggests that the risks are tilted towards a deeper and longer recession in the UK,” he said.

Capital Economics predicts that the pound could hit $1.05 by the middle of next year, surpassing the record low of $1.07 reached in 1985.

Last month, regulator Ofgem confirmed an 80 per cent rise in the energy price cap, which will mean the average household’s yearly bill will increase from £1,971 to £3,549 from October.

The rising energy bills are likely to result in a major drop in household spending, leading to fears of business closures and higher unemployment.

Steven Bell, Chief Economist (EMEA) at Columbia Threadneedle Investments said there was an "extraordinary divergence in energy prices" which was weighing on the pound.

The price of natural gas is now more than eight times higher in Europe and the UK than in the US, he said.

He predicts that the "mighty dollar could get even mightier" due to rate rises by the US Federal Reserve.

Sterling's loss is dollar's gain

Britain is already grappling with four-decade high inflation of more than 10 per cent, but Goldman Sachs recently outlined a worst-case scenario of 22 per cent.

The cost-of-living crisis has forced the Bank of England to raise interest rates to 1.75 per cent — but markets are betting that rate could be more than double by 2023.

Meanwhile, US Federal Reserve has already raised its base rate to between 2.25 to 2.50 per cent as it turns increasingly hawkish in an attempt to tame runaway inflation.

As a result, investors have shunned the euro and sterling and poured money into the dollar due to its safe-haven status and renewed confidence over the US's near-term economic outlook.

A weakened pound is also likely to add to inflationary pressures in Britain as imports become more expensive.

"It's not just sterling weakness — it's a dollar strength story," said Michael Hewson, chief markets analyst at CMC Markets. "Sterling has its problems, but they are not unique to it — high inflation, surging energy prices and falling disposable incomes."

British consumer confidence fell last month by the most since the onset of the Covid-19 pandemic and reached its lowest level since November 2020, a Bank of America survey showed on Wednesday.

"Crucially for the economic outlook, consumers are more pessimistic about their personal finances than in 2020, unemployment expectations are rising fast, and spending dropping," said BofA economist Robert Wood.

Updated: September 01, 2022, 3:55 PM