Sunak has taken over from Liz Truss as the new UK PM. The days of ‘Trussanomics’ are firmly in the rear mirror.
But what exactly does this mean for the Pound?
Tighter fiscal policy under Sunak will lead to slower growth and higher chances of a recession. This means the BoE will likely be less aggressive with rate hikes. None of this is particularly positive for Sterling.
Tuesday’s session is off to an almost completely flat start at the European open. The Dax and FTSE are unchanged since Monday’s close, and currencies are also mostly unchanged. Very minor relative weakness can be seen in the Euro with a drop of –0.15% against the US dollar and the British Pound, which remains in a contracting range.
Markets in the UK may now settle down as Rishi Sunak replaced Liz Truss as the new PM on Monday. The volatile days of Liz Truss and Kwarteng’s mini-Budget are firmly in the rear mirror, but that’s not to say there won’t be further interesting developments – Sunak is taking over a country on the verge of recession and gripped by an energy crisis. Rather than borrowing and spending his way out like Liz Truss proposed to do, cuts and austerity seem the preferred method. This makes a deep recession more likely but also assures some stability in debt markets.
How the BoE will react to the latest developments is still not completely clear. The failure and reversal of the mini-Budget does make things slightly easier for them as markets are at least functioning again. However, the prospect of a steep downturn in the economy will restrict its ability to raise rates aggressively to fight inflation.
Sunak and the Pound
Monday’s price action in the Pound gave little away on what markets thought of Sunak’s victory. GBPUSD traded higher into its 50dma but then faded and closed almost flat. EURGBP closed slightly higher. The lack of reaction was likely due to the lack of surprise – Johnson and Mordaunt never put up much of a realistic competition – and while the appointment was earlier than expected due to Johnson’s withdrawal, Sunak was always the favourite.
Looking further ahead, Sunak’s policies will certainly put the Pound on a different course than Truss in the long-term, but it could be argued this happened already as Hunt reversed the mini-Budget. Gilts have been the main beneficiaries of this move, and yields are heading steadily lower with a new low on Monday. The Pound, on the other hand, may struggle and the contracting range is a reflection of this and the uncertainty it faces. The 31st October is when Sunak/Hunt will present more on their fiscal plans and we have been warned already by Hunt that some ‘eye-watering’ decisions may have to be made to save the economy. With that in store, the Pound is gearing up for a big move.
The BoE Waiting for Their Turn
The Bank of England are unlikely to do anything drastic until Sunak/Hunt have made their announcements on the 31st October. Just a few days later on the 3rd November, the bank will have the stage as the rate decision meeting takes place. This will give them the opportunity to clarify their policy under Sunak/Hunt and exactly how they plan to tackle inflation. It is expected they will now tone down the aggressive approach expected under Truss, and this could be a negative for the Pound.
“Sunak has been voted in on a ticket of fiscal rectitude which may be good for gilts, but less good for sterling. True, the UK's sovereign risk has been re-priced lower (e.g. the UK's 5-year credit default swap trading back to 32bp from 52bp), but the prospective policy mix of tighter fiscal/less tight than thought previously, monetary policy looks to be sterling negative. After all, sterling is traded as a growth currency,” notes ING.