Market Report: Pound plunges amid political turmoil and darkening outlook

by | Jul 6, 2022

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Written by Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown

Turmoil in Westminster is adding another layer to the uncertainty hanging over the prospects for the UK economy amid a darkening global outlook. The pound has plummeted to levels not seen since March 2020 in the early days of the pandemic.

However, the flight to the dollar accounts for much of the slide in sterling we’ve seen over the last 24 hours as investors take fright about the worries about recessions hitting.

Boris Johnson’s position has appeared precarious for months, so the ministerial desertions haven’t moved the dial that much. Immediately after news of the resignations came through, the pound rose ever so slightly against the dollar. This was a subtle reaction but it indicates that a government without Boris Johnson at the helm is not being factored in as a big detriment to the UK economy. It lost ground again as he clung onto his position, dipping back to $1.192 before rising again marginally to hover around $1.195

The door of number 10 Downing Street is almost a distraction, and much of the focus will continue to be on the knock-on effects of the global slowdown, and the iimpact on the UK economy, given its fragility. The HL Savings and Resilience Barometer published this week shows the stark reality for many families – with 41% of households drawing down on savings or going into debt just to stand still.

The rise in the National Insurance threshold today will help them, but income will remain stagnant given the impact of inflation. The Bank of England underlined the deterioration in outlook, and has stressed it will still not hold back in raising interest rates more steeply, should hot inflation show little sign of cooling.

The euro has also been tumbling, heading to near parity against the dollar, at $1.02, amid worries about an impending energy crisis and corporate distress, as expectations of higher interest rates pile pressure on firms with big debts.  There will be a fresh assessment of consumer confidence later as the latest retail snapshot for the Eurozone is released. There are expectations that sales will rise by around 0.4%, but signs that shoppers are less happy to splash the cash could prompt fresh selling following yesterday’s dramatic falls on European indices.

Worries about a big global slowdown are still gripping financial markets and that nervousness is unlikely to dissipate any time soon. Stocks in Asia have fallen back again, not helped by a flurry of Covid outbreaks in China, including in Shanghai prompting more restrictions. This fresh flare up will add to the sense of unease about China’s zero-covid strategy which risks holding back a sustained recovery. The FTSE 100 has risen in early trade after yesterday’s sell off, partly helped by the weaker pound given that it helps multinationals earning in dollars, but the mood is likely to be cautious as worries persist about the impact of weakening consumer and business confidence.

Bond yields have fallen as investors seeking safer havens return to buying government debt and that helped US tech stocks listed on the NASDAQ and the S&P 500. The expectations is that if a recession hits, the Federal Reserve, will be forced to ease off the accelerator pedal in terms of interest rate rises, and could be forced to cut rates.

That’s helping tech valuations due to the way future cash flows are calculated. Minutes released later from the Federal Reserve meeting will be watched closely for any fresh indications about sensitivity of policymakers to signs of a weaker economy. Movements in the bond markets have flashed fresh warning lights of an impending recession. Yields on US government debt which matures in 10 years fell below those of 2 year notes on Tuesday, and that inverted curve worries investors as it has signified recessions in the past.

The rapidly retreating oil price was also an indicator of expectations of a global slowdown. Brent crude slid by around 8% on Tuesday before making up ground, and is now trading back above $104 dollars a barrel. Although a rapid cooling off in economic growth is expected, pushing down demand, worries about supply are likely to keep prices from going into freefall.

Now that the strike by Norwegian oil workers has been called off, that should help ease some worries, but OPEC+, the oil cartel has reiterated its concerns about capacity issues due to years of underinvestment and the impact of import bans from Russia. If Iran and Venezuela come in from the cold and sanctions are lifted against the two countries, that would relieve supply concerns significantly but there is little significant breakthrough in sight given recent separate talks with Tehran and Caracas have broken up without agreement.

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