The British Pound is currently navigating a precarious landscape as high yields and a widening budget deficit complicate its status in global markets. Even before the pandemic, as shown in Figure 2, the UK’s budget deficit has been on an unsustainable path, leading to fears about fiscal sustainability. The harsh reality has been made worse by a combination of global financial conditions as well as domestically caused problems for the UK government. The Chancellor is preparing to present a budget with plans to increase taxation by £50 billion. As a result of this unexpected development, analysts now predict the Pound to be the worst G-10 currency performer this September.
The rapidly rising yields on UK bonds are convincing investors to not hold GBP for their investments. Yet this trend only serves to mask major issues lurking within the UK’s long-dated debt. Both rising global interest rates and domestic policy challenges have had an impact. Finance analysts have long understood that high rates create an incentive to default—to lock in non-volatile debt. Because of this, the cost of financing compounds the longer they wait.
Today the UK’s inflation rate is 3.8% – set to hit 4% in September. This figure is significantly more than double the Bank of England’s 2 percent target, putting even greater pressure on fiscal policy. UK Gilts have skyrocketed to a mind-numbing 27-year highs. This wave underscores investors’ growing concerns that the federal government no longer has the will or the ability to manage its fiscal affairs.
Most troubling is that the budget deficit problems have carried on through several administrations with little meaningful fix attempted. The Chancellor’s proposed £1.5 billion tax increase set to tackle these challenges has most experts scratching their heads wondering how it will work. Thorston Bell, a leading economic analyst, brought the message home with his focus on the importance of fiscal policy on businesses. He added that “hardly a business owner” would entertain the possibility of intentionally remaining under that threshold of sales.
Of course, September has historically been a tough month for fixed income investors. Over the past decade, it has been the bond market’s worst month by far. That means investors will be closely watching all of the economic indicators as we head into September. They assume that the Pound will continue to perform poorly against its G-10 peers.
The UK’s financial landscape has had a major transformation since the onset of the pandemic. The government’s long-dated debt has through time gotten much more expensive, particularly for debt maturing in ten years or more. Both local and international forces are driving costs ever higher. All of these factors have made long-term borrowing less attractive.