Will Sterling Drop To Parity Against Dollar?

September 26, 2022

| Fullerton Markets

Will Sterling Drop To Parity Against Dollar?">

Sterling crashes on mounting fiscal concerns, printing a record-low 1.035 against the dollar before recovering to around 1.050-handle.

The decline followed the release on Friday of the UK government’s “Growth Plan,” a budget in all but name and the biggest tax giveaway in half a century. If the rout continues and widens into broader markets, there is a risk Prime Minister Liz Truss’s days-old administration may be pushed into a crisis that could force a rapid policy response.

In the wake of last week’s mini-budget, the pound's tumble shows little sign of relenting. How low can it go, and is $1 the floor? One potential answer can be drawn from the yen’s collapse this year, and that answer would be that the sterling can go meaningfully further below its current level.

Looking at real effective rates, which factor in relative inflation metrics, the yen dropped to a record this year based on IMF data going back to 1980. Its nadir so far was 13% below its previous trough.

At the end of last month, the pound was sitting about 6% above its record low, so it may have already crashed through it with this month’s 9% slide. However, a similar swoon to the yen could take it well through $1, depending on how much a drop takes place against the dollar.

While the UK’s monetary policy is not as loose as Japan's, the government’s fiscal policy may more than make up for that to drive the pound lower and lower. There seems to be little respite for the pound after Friday’s tumult.

The pound will face an additional test of nerves when gilts open for trading later in the European morning. A surge in yields may, ironically, test the currency even more rather than come to its aid amid the current backdrop.

Central banks are racing to get on top of elevated inflation, despite mounting signs of a sharp slowdown in growth. For the world as a whole, that means the GDP-weighted central bank rate will rise from 2.9% at the end of 2021 to 5.1% at the end of 2022. Focusing on advanced economies, the jump is from 0.1% to 2.9%.