As of mid-June it had lost 4 per cent against the euro, although those losses have been recouped.
As with all things in markets there are several drivers behind this poor performance. A struggling economy has had its life made much more difficult by the disruption caused by Brexit, and the Bank of England has seen its thunder stolen by the Federal Reserve and others, which have moved with greater rapidity to tackle inflation.
Looking ahead to the rest of 2022, it does not seem like there is any immediate improvement on the cards, suggesting the second half of the year will be as tough as the first.
It’s the economy, again
The latest GDP data show that the British economy grew by 0.5 per cent in May, beating the gloomy forecasts made after the 0.2 per cent contraction of April.
But while this means recession worries have eased a little, they have not gone away entirely. The outlook remains quite difficult, to say the least.
May’s data showed that output in sectors like pubs and entertainment venues was down 0.1 per cent, and remains almost 5 per cent below the pre-pandemic high.
Overall it seems like the UK is in for a very weak recovery from the pandemic, and it is expected to be around 1 per cent larger in 2023 than it was in 2019 – hardly the kind of vigorous economy that can provide good employment prospects for workers and present the BoE with the foundation to speed up its rate hiking policy.
Brexit still looms large
It is not particularly controversial to say that the UK’s decision to leave the EU, and the deal negotiated by the British government, have resulted in a major dislocation of the UK economy.
Per capita income, according to the OECD, is up 3.8 per cent in real terms for the UK, but 8.5 per cent for the remaining 27 EU states. Since Q2 2016, GDP growth for the EU is around 9 per cent, and just 4 per cent for the UK.
While the pandemic muddied the waters, the gap between the two has become wider since the UK’s official departure in 2020. The changes to regulations and worker access, as well as the prospect of further divergence in a host of areas, has meant that UK business competitiveness has been hard-hit, and wage growth has suffered too (with the picture complicated by the surge in inflation this year).
One of the effects of the pandemic has been to distort economic cycles. Because the UK exited pandemic restrictions earlier than many European countries, it entered an economic recovery phase sooner, and reached the mature stage of the recovery earlier than the eurozone, which is entering the strongest bit of the cycle now.
2023 does not appear to offer much in terms of a rebound. The UK’s growth is expected to be the lowest in the G20, leaving aside the impact on Russian GDP from sanctions. In addition, the Office for Budget Responsibility says it still expects a hit to GDP of around 4 per cent from Brexit, with half of that impact yet to come.
Trade flows and business investment have also suffered, due to the increased trading barriers arising from Brexit. Taken together, these problems simply bolster the case for thinking the UK will be unable to skirt a recession in the second half of the year.
Cautious BoE leaves pound lacking support
While Threadneedle Street might have helped fire the starting gun of 2022’s policy tightening among central banks, the Monetary Policy Committee has since been overtaken by the likes of the Fed and the Bank of Canada.
The BoE has steadily raised rates – but in 25 basis point increments. Over in the US, the Federal Open Market Committee has moved from 25bp to 50bp and now 75bp. In the wake of the latest US consumer price index figures, even a 100bp rise is now being suggested. But in the US the economy looks stronger – employment is more robust and the economy there has not undergone a major status change vis-à-vis its most important trading partners. The MPC’s caution is certainly justified – the above problems besetting the UK economy mean that a more aggressive policy risked tipping the UK into a recession, which in itself would have done little for the pound’s prospects against the dollar.
It is notable that the pound has done better against the euro, which makes sense given that the European Central Bank has had to be dragged kicking and screaming into contemplating rate hikes. Frankfurt is likely to move just as gingerly as its counterparts in the UK have done, indicating that, on this basis at least, the euro might not have much of an edge over the pound. That might also change as the second half of 2022 goes on, and is something to watch over the summer and into the autumn.
The big hope for a GBP/USD rebound comes from the possibility that the Fed will ease off after its next meeting.
Despite the 9.1 per cent CPI reading in the US, the recent slump in commodity prices might point towards a weakening of inflation increases, which could result in the Fed slowing and even pausing its tightening policy to assess the next steps. This however would require the BoE to press on with even a cautious hiking policy, something that is also in question in the medium term.
The pound’s future still looks tough. Weak GDP growth, a possible recession, further disruption from Brexit and the problems of competing monetary policies make it hard to argue that sterling is due for a sustained rebound against the dollar, and even against the euro it has a difficult job ahead of it. There is still a way to go before GBP/USD returns to its 2020 lows, but this remains a distinct possibility.
Chris Beauchamp is Chief Market Analyst at IG Group
