Sterling’s slide against the dollar sparks fears of economic spiral

The pound fell to as low as $1.1407 on Wednesday, as investors grew worried about the country's economic outlook

A foreign exchange dealing room in Seoul, South Korea.  AP Photo
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Sterling’s slide against the dollar to a rate last seen in 1985 has sparked concerns that the plunge could represent the start of a dramatic UK economic downturn.

Some have said it could trigger a collapse in confidence in British assets and a balance of payments crisis.

Fund managers, analysts and former policymakers say such a scenario is unlikely, but they suspect the pound will need to become cheaper before investors buy the currency again.

The currency fell to as low as $1.1407 on Wednesday, as investors took a dim view of the economic outlook under new British Prime Minister Liz Truss.

On Thursday, Ms Truss is due to unveil a £100 billion ($114.8bn) package to cap consumer energy bills for homes and businesses, funded by a massive increase in government borrowing.

In an interview with Sky News, the new levelling-up secretary, Simon Clarke, dismissed the idea that the proposals prompted the plunge in the pound.

“We all obviously would never want to find ourselves in this situation,” he said. “And there is no question that it is the latest in a series of quite extraordinary interventions that the government has had to make to support families, which obviously reflects our determination to do the right thing for the British people.

“But let’s be clear, if we fail to act. If we don’t protect the economy against the shock of the size and scale we are talking about then there is going to be enormous economic damage in any event.”

He said the hardship caused by the proposed rise in the energy price cap in October and beyond would be “enormous”.

The government was already hearing from businesses about their inability to pay.

“And so we could have anticipated I think a huge amount of damage to the economy had this rise gone ahead unchecked,” he said.

“So you are balancing, frankly, two very challenging things. In these circumstances markets will respect that this is the most sensible thing to do.”

Ms Truss is under scrutiny as she gets ready to cut taxes and raise spending in a gamble that loosening the fiscal purse strings — at a time of double-digit inflation — will boost economic growth.

“The market has moved very far and very fast in the last couple of weeks, in the face of what is a relatively bleak economic outlook. That means there will be a recession but it will be deeper in the UK,” said Charles Diebel, head of fixed income strategy at Mediolanum Asset Management, which is betting against the pound.

Britain faces slower economic growth and more persistent inflation than any other major economy next year, the International Monetary Fund forecasts, and Goldman Sachs expects the UK economy to contract by 0.6 per cent in 2023.

“The currency is cheap but probably needs to be cheaper,” Mr Diebel said.

Several economists including top economist Mohamed El-Erian forecast the pound will hit $1.10 soon, implying a further 4 per cent fall from current levels.

Capital Economics believes sterling could test its all-time low of near $1.05, plumbed in March 1985, just before G7 powers acted to rein in the “superdollar” of the Reagan era, in the so-called “Plaza Accord”.

Yet the rush to dump British assets has been driven by international developments too, including soaring gas prices and global growth worries that have driven investors to seek shelter in the dollar. The euro and yen have also hit multi-decade lows.

Updated: September 08, 2022, 10:38 AM