Recession-related malaise drives sterling down to worst quarter since 2008

As the UK economy teeters on the brink of recession, investors are giving up on the pound.

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(Bloomberg) – In the words of economists at AllianceBernstein this week: « The UK economy is coming apart. »

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The evidence is everywhere. Households are losing their purchasing power, the cost of basic necessities is skyrocketing and business confidence is at rock bottom. The pound just had its worst quarter since 2008 and fell below $1.20 on Friday.

With economic reports pointing to a global slowdown, the UK’s position looks particularly precarious. Goldman Sachs Group Inc. puts the odds of a recession in the UK at 45% over the next 12 months, compared to 40% for the eurozone and 30% for the US.

This gloomy picture drives investors away from UK assets and puts an end to M&A activity. Nomura Holdings Inc. currency strategist Jordan Rochester urged clients to sell the pound betting it will fall to $1.18 in early August.

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« It’s too early to believe the pound is cheap enough to rally without some improvement in UK growth prospects, » said Neil Weller, head of global currency strategy at JPMorgan Asset Management.

Here’s a look at what’s happening in the UK markets:

Pound sterling

The pound weakened 7.3% against the dollar during the second quarter and is trading at levels close to the levels seen at the height of the Covid pandemic. « Boris Johnson’s leadership is in doubt and longer-term ideas such as a Scottish independence referendum next year could weigh on investment flows, » Rochester of Nomura wrote.

UK stocks

The blue-chip FTSE 100 index fared better due to its heavy weighting in energy producers and banks. Still, strategists are beginning to highlight the worries on the horizon. “Recession is a risk for all stocks and the FTSE 100 has large-cap consumer names that would be susceptible,” wrote Goldman strategists led by Sharon Bell. The FTSE 250 index, a benchmark for UK mid-cap stocks, plunged nearly 9% in June.

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Corporate debt

UK junk bond yields have topped 9%, the highest since 2020, and more companies are plunging into troubled territory. A note issued to back a private equity takeover of Asda is trading at 77 pence a pound.

Gilt market

The search for safety pushed investors back to the bond market. Yields on two-year gilts fell 16 basis points on Friday to 1.68%, the lowest in a month.

Next week

• European Central Bank President Christine Lagarde is due to speak in France on July 8 at the end of a long list of appearances officials have planned for next week. Policymakers are preparing to raise rates for the first time in more than a decade later this month with inflation at an all-time high.
• Citi strategists expect around 23 billion euros ($23.9 billion) in supply from sovereign issuers, including Austria, Germany, France and Spain. The ECB stopped buying net asset purchases under the APP from July 1.
• Traders will look to speeches from Bank of England officials including Huw Pilland Jonathan Cunliffe in the absence of a policy meeting in July. On Friday, traders cut bets on the pace of the BOE’s rate hikes, pricing less than 150 basis points of tightening by the end of the year for the first time since June 7, as concerns grow on the health of the UK economy.
• Next week’s economic figures include French and German industrial production and the Dutch CPI.