British pound falls to lowest level since 1985 as UK economic pain grows

The British pound fell to its lowest level against the US dollar since 1985, reflecting the dire economic situation of the UK economy. Investors are bracing for the pound to weaken further to a low not seen in more than two centuries of transatlantic trade.

The pound fell 0.3 percent in early trading Monday in Asia to $1.1475, according to FactSet. This is the lowest level since 1985. Sterling’s fall is partly a side effect of the US dollar’s relentless rally, which has like the euro and Japanese yen to multi-decade lows in recent days.

But the problems are also domestic. The UK is facing energy crisis which threatens to leave many households unable to pay their bills this winter. Uncertainty about both economic policy and The next Prime Minister of Great Britain will take effect and the Bank of England’s ability to control extremely high inflation compound the pound’s weakness.

“The economic challenges facing the UK economy are probably as great as anything we have seen in living memory,” said Mark Dowding, Chief Investment Officer of BlueBay Asset Management.

Goldman Sachs

warned that UK inflation could hit 22% next year amid spiraling energy costs, one of its starkest forecasts yet. The bank estimates that the UK economy would shrink by 3.4% under this scenario.

Mr Dowding believes the pound could fall to parity or a 1-to-1 exchange rate against the US dollar next year. The pound has never been worth less than $1 in the more than 200-year history of the currency pair – although it came close in 1985, when the pound fell to $1.05 before the world’s biggest economies joined forces are to weaken the US dollar under the so-called called Plaza Accord.

“There’s a really dark path that you’re taking that the UK almost has to go back to [International Monetary Fund] for a bailout as a quasi-emerging market crisis,” Mr. Dowding said. In 1976, the pound crisis forced the United Kingdom to request a $3.9 billion loan from the IMF. “That’s the worst-case scenario,” he said.

The British pound was once the world’s most famous currency. But the value of the pound has been in steady decline over the past century, coinciding with the erosion of its status as a major currency in world trade and central bank reserves. The Brexit vote in 2016 dealt another heavy blow, leading to headline-grabbing comparisons between the pound and risky emerging market currencies.

More die-hard investors and analysts have dismissed the comparison as hyperbolic, but some are beginning to recognize a growing list of similarities.

Adam Cole, chief currency strategist at RBC Capital Markets, is concerned that the typically positive relationship between UK interest rate expectations and the pound appears to have broken down.

In normal times, higher interest rates make holding a currency more attractive because investors receive higher returns. But yields and the pound have recently gone in the opposite direction.

The pound fell 4.6% against the dollar in August, its worst month since October 2016.

Meanwhile, the yield on 10-year UK government bonds rose to 2.880% from 1.808%, the biggest monthly increase since 1990.

“Periods where interest rate expectations rise and the currency falls are something we expect to see in emerging markets rather than developed markets,” Mr Cole said.

Mr Cole said the breakdown in the correlation reflected doubts about whether the Bank of England’s plans to raise interest rates would ultimately succeed in controlling inflation.

The pound is also vulnerable to ever-growing deficits that have left the country dependent on what former Bank of England governor Mark Carney described as the “kindness of strangers” or foreign investors to plug funding gaps.

The UK’s current account deficit, a broad measure of trade flows and income, widened to a record 8.3% of gross domestic product in the first quarter, partly due to rising fuel import costs.

For the most part, foreign investors are happy to play this role, buying up British companies, government debt, property and shares. One of the benefits of a weaker pound is that it makes assets appear cheaper to foreign investors, as well as making UK exports more competitive abroad.

“The UK has always lived beyond its means,” said Guillaume Paillat, multi-asset portfolio manager at

Aviva Investors.

Sustained demand from foreign investors for UK equities is “the only way the UK can close this gap”, he said.

How have China, Mexico and Greece handled inflation and where does the US fit in? The WSJ’s Dion Rabouin explains.

Foreign investors sold £16.5 billion worth of UK government bonds in July, according to data from ING and the Bank of England, the biggest amount since July 2018. Meanwhile, international investors reduced their holdings of UK stocks. A Bank of America survey of global fund managers showed 15% of UK stocks were undervalued in August, compared with 4% in July.

The Conservative Party leadership race is set to end on Monday, with Foreign Secretary Liz Truss set to step down considered a likely successor to Boris Johnson as Prime Minister. Ms Truss has promised to cut taxes but has not provided details of her plans to tackle rising inflation and energy prices. Increasing the government’s borrowing needs could further test investors’ willingness to finance it.

“If you get easier fiscal policy – more likely tax cuts – that means more imbalances,” Mr Paillat said.

Write Chelsea Dulaney at [email protected]

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