The British pound may remain volatile for now

The British pound has been at the centre of market volatility in recent weeks, sparked by the reaction of financial markets to the UK mini-budget. There doesn’t seem to be a definitive end to this, even though the resignation of Former Prime Minister Liz Truss has acted as a temporary stabilizer for the currency.

With regards to the UK market, there are several underlying drivers behind the sharp moves that have taken place. There were many steps taken by both the Bank of England and the UK government that precipitated the situation but alarm bells started ringing as soon as further expectations of monetary tightening by the Bank of England grew upon the announcement of a so-called mini-budget by the UK government on the 23^rd of September. This caused the pound to fall in value, which was detrimental because a weakened pound left consumers with less buying power.

Another cause of concern was the market turmoil that ensued. Volatility was observed in the FTSE 100 Index, which includes the largest 100 companies listed on the London Stock Exchange. The uncertainty resulting from the competence of the government’s leadership during this time is what is thought to have caused the market’s negative reaction.

The market was already struggling as a multitude of UK companies faced demands for more liquidity. To make matters worse, pension funds were forced to offload part of their holdings of UK government bonds, or gilts, at distressed prices after the government’s announcement of tax cuts sent yields soaring, triggering margin calls on derivatives designed to protect the funds against movements in rates.

According to new data, the economic activity in the UK was poor in multiple areas, including real estate, which has since seen growth subsiding. This was due to the rise in borrowing costs which reduced home-loan affordability, with some lenders also pulling their mortgage products from the market.

In addition, unemployment in the UK hit a multi-decade low around August, as data from the Office for National Statistics showed that unemployment stood at 3.5 per cent, which is 0.3 percentage points down on the quarter. With the potential of two decades of lost wage growth, the Bank of England’s forecasts have been dim. These are not the only problems that the UK faces, and the nation has so far had a poor track record in dealing with its economic issues in 2022.

The pound recovered to $1.126 and gilts rallied after Jeremy Hunt was appointed Chancellor of the Exchequer on Friday 14^th October. The British pound traded just above $1.125 after rising to almost $1.13 earlier in the session previous to that. In a statement, Hunt said he would reverse almost all previously announced tax measures that were suggested by his predecessor, Kwasi Kwarteng. The 30-year gilt yield went down after he took over, reflecting higher market prices as companies seemed to have drawn comfort from this move which, in turn, restored some confidence in the UK’s fiscal position.

Liz Truss quit as UK prime minister, drawing a close to her 44 days in office which saw her preside over an economic meltdown and reputational concerns flowing towards the ruling Conservative party. Following a market crash and a U-turn on her budget proposals, the announcement came as Britain was still facing risks of recession amid political and financial turmoil driven by the surge in natural gas prices, post-Covid supply-chain bottlenecks, and labour shortages.

In summary, the actions of the Bank of England—namely, stepping up its interest rates to combat persistently high inflation—in combination with the decisions taken by the former UK Prime Minister, Liz Truss, have caused market turbulence in both the UK stock market and in the pound sterling. Possible future actions of UK government leadership may cast doubt on the stability of the UK economy and the British pound. At this stage, the smooth leadership of the country seems crucial for economic recovery.