Published: September 7th, 2022
Britain’s economy may be ‘hard-wired’ to undermine Sterling over the long-term, that’s the view of a recent analysis by global lender HSBC.
The bank says trends in UK output suggest Blighty won’t be able to sustain a currency that can post gains over a multi-year timescale. The only way out of the trap is to reduce reliance on imports, an issue that exposes GBP to the whims of offshore investors.
Because Britain is a net importer, in economic terms the country spends more than it earns. For HSBC that represents a 'core' problem that could mean bearish prospects for the Pound.
‘Manufacturing and selling more than you buy provides a fundamental strength that is crucial for fiat currencies,’ the report from HSBC’s European FX Unit says. ‘With a strong and stable source of funding, Sterling would be less vulnerable to global headwinds and be on a better footing to make gains’.
‘For both Sterling and the Euro, the picture looks increasingly worrying’.
The bank believes the UK and Eurozone are going to be challenged by a cyclical dynamic that wraps together higher inflation, weaker growth, and tightening monetary policy.
‘The more concerning medium-term threat is the deterioration in both currencies’ core balances’.
AUD is an example of a currency that continues to see gains thanks to a strong core. The country’s trade balance continues to grow as it exports in demand commodities like natural gas, coal, and iron ore to global buyers.
Britain’s current account deficit has only grown wider as these are exactly the types of commodities the country tends to import, alongside other goods.
That means the Pound can only sustain value if the import/export gap is funded by other means, typically through an inflow of money from international investors looking to buy up British assets.
It's a precarious funding source for Sterling to base its value on, something past Bank of England Governor Mark Carney called the forex equivalent of ‘the kindness of strangers’.
That theory runs counter to recent trends. Sterling has more or less held on to recent levels against its EUR and USD peers thanks to economic figures that show UK wages rose faster than expected in June, while job vacancies remain high in an environment of low-unemployment.
On two consecutive prints this year the UK government’s Office of National Statistics (ONS) has said average British earnings were on the rise, with an increase of five per cent in June when bonuses were included. That was above the 4.5 per cent market consensus expected, though less than May's 6.1 per cent rise.
Average earnings excluding bonuses rose by 4.6 per cent, above market expectations of 4.5 per cent and bettering the 4.3 per cent growth posted in May.
While earnings were still well below inflation, investors thought Britain’s central bankers would keep raising interest rates, since wage settlements were elevated relative to longer-term trends.
An analyst note from Econometrics said that 'with wage growth going well past the rates of three to 3.5 per cent one would expect with a two per cent inflation target, it confirms our view that the Bank of England (BoE) will need to raise interest rates beyond the three per cent most analysts are expecting.
The firm said that ‘this is the second raft of labour market data that doesn’t show conclusive evidence of cooling wage pressures. That could conflict with plans by Threadneedle Street for interest rate changes based on weaker consumption’.
The UK’s unemployment rate held firm at 3.7 per cent in June, as the number of people in employment rose by 160K on the quarter. July estimates for the number of payrolled employees expected a monthly increase, rising by 72K on the revised June figures to a record 29.6 million.
The UK employment rate dropped by 0.1 percentage points for the quarter to 75.3 per cent, suggesting more people returned to the labour market. The ONS also noted a decline in the numbers of adults categorized as ‘no longer seeking work’.
In May, GBP rose against the Euro and Dollar after publication of Q1 UK labour market data that also revealed a strong rise in wages and a bigger than expected drop in unemployment.
Numbers from the UK’s Office of National Statistics (ONS) showed that Britain added more than 82,000 jobs in the three months to March, well beyond consensus.
The rate of unemployment also made a surprise drop to 3.6 per cent from 3.9 per cent, the lowest level seen in five decades.
‘Even with the slowdown in growth seen in March, the UK labour market is simmering with record openings and lateral employment moves,’ said the Confederation of British Industry (CBI) in a press statement.
Average Wages, including bonuses, spiked by seven per cent in March, much more than the 5.5 per cent markets were expecting.
The overall economic print was stronger than expected, sustaining pressure on the Bank of England (BoE) to continue its cycle of interest rate hikes. Econometrics says that because that the UK’s labour market was, and remains, ‘very tight’.
‘The big rise in employment in June alongside accelerating wage growth has kept the pressure on the Bank of England to lift interest rates. Even when you factor in people moving out of self-employment and the recent fall in real wages, the figures we’ve seen this year indicate a strong rebound of the British labour market’.
Looking to the longer term, unemployment could start rising and wage growth could stall as immigration increases the supply of workers and job vacancies start to fill. It may already be happening. The number of job vacancies fell 19.7K in the quarter to August reaching 1.27M, the first quarterly drop since 2020.