UK banks favor inflationary measures over GBP Price
By Paul Reid
16 January 2023
Currencies are sensitive and affected by everything from war to weather, politics to pandemics. Forecasting a major currency usually takes time, diligence, and a lot of data… but that might not be true for GBP in 2023. Should you short GBP this year?
The Great British Pound had one of the most volatile years on record in 2022 against USD, its worst annual performance since Brexit in 2016. GBP has been on the decline for over 50 years, but in September 2022, GBPUSD almost traded at parity, dropping as low as 1.0697. The last time GBP was that low was in 1984.
Clearly, the UK has had challenges over the last few decades, but the hardship is far from over.
UK interest rates spiraling
When the UK’s inflation is high, there is a depressive effect on GBP. This is because increased inflation reduces GBP’s buying power, weakening it against other currencies. As inflation rises, the Bank of England (BoE) has no choice but to raise interest rates.
Interest rate hikes typically boost currency value.
In November 2022, the BoE raised the interest rate by 75-basis points, taking the benchmark rate to 3%. The biggest rate change to happen in 33 years. And then in December, the BoE raised rates by an additional 50 basis points. That was the ninth interest rate hike of the year. Even with so many interest hikes, GBP did not fare well. So why didn’t it work?
High interest rates can also crush consumer confidence, increase unemployment, and decrease salaries. It’s a delicate balance, allowing inflationary fires to burn wild for a while, before powering up interest rates to calm the economy.
High interest rates mean the borrower has less cash to spend on other things. Less spare cash means households spend less. Less consumer spending means businesses will avoid raising prices.
The sign of a strong economy is when both inflation and interest rates are low. The UK is suffering from both high inflation and high interest rates, but they are fighting to regain solvency.
2022 damage control
Raising interest rates can help in the long run. The trouble is, it can take as much as two years to see raised interest rates having a full effect on inflation. Fortunately, the BoE was on damage control throughout 2022, placing costly economic cushions throughout the UK’s financial infrastructure in preparation for a big drop. That was the volatility of 2022 that created such astonishing and bearish GBP trading charts.
As a result of the 2022 damage control, GBP might be over sold and undervalued right now… a desirable situation for the Brits right before a recession. The only question, are the measures enough to keep GBP above parity with USD?
Trading GBP in 2023
The Consumer Prices Index (CPI) rose by 10.7%, the highest annual inflation rate in over 25 years. High inflation devalued GBP, so the BoE raised interest rates to 3.5% in response. Rising interest rates are supposed to have a bearish effect on GBP, so is it a buy low, sell high moment?
GBP might be low, but that doesn’t mean it won’t get lower. There’s nothing on the horizon that could give GBP a positive boost, and now multiple statements from UK and international economists are claiming the UK will be one of the hardest hit countries in Europe when the recession finally kicks in.
The UK is still suffering from post Brexit fallout in banking and import/export sectors. Then there’s the growing energy crisis, and COVID aftermath. Changing Prime Ministers with every season doesn’t help investor confidence or market sentiment either.
Most relevant is what the BoE said recently. It would rather see a weaker recession than a weaker currency. That opens the door to currency value crashes as inflation compensation becomes a priority in 2023.
If you do plan on trading GBP, keep an eye on the UK’s inflation and interest rates. If both inflation and interest remain high or increase while GBP doesn’t show signs of recovery, the UK and GBP are in deeper water than we all think.
Trading volume could be epic in the coming months, and overbought/oversold scenarios will be common, so your reaction times will need to be fast to maximize your trading potential.
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