Sterling’s Slide Deepens Amid Fiscal Sustainability Concerns and Rising Gilt Yields
The British pound continued its descent against the US dollar and the euro on Monday, reaching lows not seen since November 2023. This decline is fueled by growing investor anxieties surrounding the UK’s fiscal health, exacerbated by a sixth consecutive day of rising gilt yields. The pound dipped as much as 0.7% against the dollar, touching $1.21 before settling slightly higher. Against the euro, the pound lost 0.3%, trading at 84.13 pence. These developments place the pound squarely in the crosshairs of global currency traders, as British markets grapple with surging bond yields, a trend originating in the United States due to persistent inflation worries and diminishing expectations of Federal Reserve rate cuts.
The surge in global bond yields gained further momentum following the release of robust US labor market data on Friday. This data reinforced the view that the Federal Reserve might hold interest rates higher for longer than previously anticipated, with money markets no longer fully pricing in any rate cuts this year. While higher yields typically bolster a currency’s value, analysts in Britain believe that rising borrowing costs could compel the government to curtail spending or implement tax increases to adhere to its fiscal rules, potentially hindering future economic growth. This concern weighs heavily on the pound’s performance.
Experts highlight the UK’s vulnerability to rising interest rates and inflation. Dominic Bunning, Head of G10 FX Strategy at Nomura, points out that the current market dynamics are not a direct consequence of recent UK actions but rather a reflection of the country’s sensitive fiscal position in the face of rising rates and inflation. The key question now revolves around whether a stabilization of yields would provide enough relief to slow or pause the pound’s sell-off.
Adding to the pressure, the UK’s 10-year gilt yield climbed to 4.855%, hovering near its highest level since 2008, recorded last week at 4.925%. Last week alone, the yield surged by over 24 basis points, marking its most significant weekly increase in a year. Furthermore, the 30-year yield reached its highest point in 27 years on Monday, hitting 5.472%. These escalating yields reflect growing investor concerns about the UK’s long-term borrowing costs and the sustainability of government debt.
Prime Minister Keir Starmer reaffirmed the government’s commitment to the fiscal rules outlined in finance minister Rachel Reeves’ October budget and expressed full confidence in her leadership. However, the market showed little immediate reaction to these assurances. Reeves’ budget provided a very narrow margin for achieving her target of balancing public spending with tax revenues by the end of the decade. The recent surge in borrowing costs, combined with sluggish UK growth data in the latter half of 2024, makes reaching this target increasingly challenging.
Market attention is now turning to the upcoming release of British inflation data on Wednesday. Economists anticipate consumer prices to have risen by 2.6% annually in December, consistent with November’s figures. However, core CPI is projected to have moderated slightly to 3.4% from 3.5%. This data will be crucial in shaping expectations regarding the Bank of England’s (BoE) next interest rate decision. A higher-than-expected inflation reading could further pressure the pound and fuel speculation about potential rate cuts. Conversely, a moderation in core inflation might offer some respite to the currency. Futures markets currently price in around 16 basis points of easing at the BoE’s February meeting, suggesting a roughly 65% probability of a quarter-point rate cut. A potential rate cut could further weaken the pound, potentially pushing it towards the $1.20 level. The interplay between inflation data, interest rate expectations, and fiscal concerns will continue to drive sterling’s trajectory in the coming days and weeks.
