Stagflation and Risk-Off Sentiment To Weigh on GBP

Today marks the sixth anniversary since the Brexit vote, which triggered a significant surge in uncertainty that has been weighing on the economic activity. UK switched from being the best-performing economy in 2014 among the G7 to one of the weakest-performing economies in recent years. The UK is expected to be the worst-performing economy next year among G20 (after Russia) following the recent significant downward revision by the OECD, from 2.1% to 0%.

Hence, the stagflationary environment should continue to weigh on the British pound, which remains ‘cheap’ but very risky. In addition, the risk off sentiment driven by the geopolitical uncertainty and the sharp tightening in financial conditions (surging ST rates) leave equities vulnerable in the near term, which could also impact Sterling quite significantly.

Historically, the pound has been the most sensitive currency to high-volatility regime; periods of sharp drawdowns in equity markets are generally associated with aggressive pound selloff. For instance, Cable plunged from 1.32 to a low of 1.1412 during the March 2020 market panic.

The chart below shows the strong co-movement between GBPUSD and EM equities in the past 6 years (since Brexit), and therefore further retracement in equities (amid lack of visibility and convictions) leaves Sterling vulnerable in the near term.

Figure 1: GBPUSD vs. EM Equities (source: Bloomberg)