Cable has been under pressure since the start of the month as the dollar has regained its mojo amid progress in trade negotiations. But part of that is also due to the shaky situation in the UK. The pound hasn’t been able to capture as much of the loss in the dollar as the Euro has. Traders have been nervous about the state of the UK’s finances, and a return to growth could help reassure the markets.
UK Chancellor Rachel Reeves is reportedly facing a £20 billion shortfall in government finances as she works on the Autumn Budget. This has gotten markets increasingly nervous, particularly after earlier this month there were rumors circulating she might resign. She’s repeatedly tried to reassure markets that the government won’t raise taxes or borrowing, but is running out of political options. Colleagues in the Labour Party are increasingly pushing for more taxes, including a wealth tax.
Hitting Obstacles
Why a wealth tax would particularly upset the markets can be viewed in recent economic data. May UK monthly GDP is expected to rebound and grow at 0.1% after falling -0.3% a month before. April’s contraction was the first in six months and the worst in nearly two years. The main causes for the drop were attributed to increased taxes on national insurance and stamps that took effect in that month, as well as higher energy prices.
PMI figures for May and June, however, suggest that the contraction of April was temporary. In fact, services activity hit a ten-month high in June. If the UK economy experiences a rebound, it could provide relief to the embattled Chancellor. Faster economic growth means the Treasury collects more taxes and could help ease the pressure to instill revenue measures that would scare the markets.
No Help from the BOE
The other factor affecting the situation is the (Bank of England) BOE’s inability to lower rates as inflation remains persistently well above target. The bump up in inflation also seen in April has been attributed to increased costs from taxes as well. While Governor Andrew Bailey has insisted that the trend for interest rates is to the downside, economists believe it is still too early to expect rate cuts given the inflation situation.
Normally higher interest rates would be seen as supporting the currency, but it’s the lack of economic growth that is keeping investors wary of buying pound-denominated assets. Unless there are clear signs of the economy improving, or inflation easing enough for the (Bank of England) BOE to start easing, the pound could be under pressure through the summer as traders await the Autumn Budget.
What Can Be Done
In the meantime, cable might move more based on what’s happening in the US than in the UK. Britain is one of only two countries to have already secured a trade deal, meaning that the pound might be a little more insulated from trade-related talk.
Economists are still generally agreed that the (Bank of England) BOE will deliver three rate cuts in the second half of this year. But the timing remains uncertain, and a surprise in the GDP figures could easily change those projections.
