British Pound: External flows and fiscal risks – BNY

Geoff Yu at BNY argues that the Pound’s (GBP) resilience cannot rely solely on higher rate expectations as United Kingdom (UK) political uncertainty and prospects of fiscal loosening weigh on gilts. He warns that external bond inflows, which historically supported GBP, may be fading, leaving the currency vulnerable to asymmetric downside if fiscal concerns trigger renewed outflows.

Pound reliant on external support

"GBP has held up better, but we are not enthused by current pricing, which has shifted back to three rate hikes for the rest of the year, this time driven by domestic factors rather than global supply pressures. The market clearly believes that, whatever the political denouement, fiscal loosening is inevitable, which would force a different Bank of England reaction function."

"GBP cannot rely on rate expectations alone for resilience. We maintain that tightening anywhere in Western Europe could exacerbate demand stress, and policymakers do have the capacity to lean more on domestic restraint and a high savings rate."

"The data show that such strong inflows have historically benefited the currency, but toward Q4 last year, some of the support was already starting to wear off. Consequently, GBP now faces flow asymmetry: yield-driven inflows merely support valuations, while fiscal premium-driven outflows could trigger a sharper downside."

"GBP’s NEER remains above long-term averages, and fiscal authorities – current and future – will need to watch currency reactions as closely as gilts through the next parliament."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)