Pound rises as inflation soars and PM appears on brink
By Jenni Reid
14:52, 19 January 2022
Sterling rose against its main rival currencies Wednesday as inflation in the UK reached a 30-year high amid a deepening political crisis that threatens prime minister Boris Johnson’s position.
In early afternoon trade in London, the pound (GBP) was up 0.33% versus the US dollar at $1.364, up 0.18% against the euro at €1.202 and up 0.23% on the Japanese yen at ¥156.143.
The latest rise follows a rally last month by the pound against the dollar and euro, which has only reversed slightly against the dollar in recent days.
What’s happening in the UK, and what does it mean for the currency?
Inflation ups chance of interest rate rise
Data published this morning showed the Consumers Prices Index (CPI) climbed 5.4% in December, up from 5.1% in November. A poll of economists by Reuters had predicted a 5.2% rise.
Core inflation, excluding food, energy, alcohol and tobacco, was up from 4% to 4.2%, and several analysts reiterated forecasts of further rises in the months to come.
Jane Foley, head of FX strategy at Rabobank London, said the news had “re-ignited fears that the Bank of England could step up the pace of [rate] hiking this year,” which was supporting the pound.
“On first sight the numbers endorse market expectations that the Bank could raise rates by at least 100 basis points on a one-year view starting with a 25 bps move in February,” Foley told Capital.com
“That said, with higher energy and food prices already slashing real wages, there is a strong risk that demand will already fall back this year. In our view, while the Bank could hike again in February, the drop in real wages will lean against the prospects of progressive rate hike later in the year.
“This suggests there is a risk of a drop back in the value of GBP in the second half of 2022.”
ING analysts Chris Turner and Francesco Pesole at ING said: “An awful lot is priced for the Bank of England cycle – yet we think it is too early to ‘fade’ the GBP rally on a fully-priced Bank cycle, just in the same way it is too early to fade the dollar rally.”
The analysts forecast EUR/GBP will continue moving towards the 0.8270/80 area, with Bank Governor Andrew Bailey making hawkish comments on inflation this afternoon, and despite political turmoil.
What is your sentiment on USD/JPY?
Johnson under pressure
That turmoil involves outrage among the public and politicians over reports of numerous parties being held at 10 Downing Street, the prime minister’s residence and office, while the UK was under strict lockdown rules.
Johnson has been under increasing pressure to resign after admitting he attended a gathering of several dozen people in the garden of number 10 in May 2020, to which his private secretary invited 100 colleagues and allegedly instructed them to “bring your own booze!”
The PM defended his action with a claim he attended the gathering for 25 minutes and believed it was a work event. He did little to quell the anger by saying in an interview Tuesday that he was not told the party would breach the rules his government set.
A growing number of members of parliament within his Conservative party are reportedly submitting letters of no confidence in his leadership, though the exact number is kept confidential. If 54 letters are submitted, the PM will face a leadership contest, though Johnson may choose to step down rather than face a leadership challenge.
Ahead of Prime Minister’s Questions this afternoon, Tory MP Christian Wakeford defected to the opposition Labour party, reportedly telling Johnson: “You and the Conservative Party as a whole have shown themselves incapable of offering the leadership and government this country deserves.”
If no leadership challenge is triggered in the coming days, the next threat to Johnson’s premiership will come in the results of a civil service-led inquiry into whether rule breaking occurred, which could fan the flames further.
Pound unbothered
The pound has so far shrugged off the scandal, which has been rumbling on for more than a month.
“The fact that there is no general election scheduled until 2024 is insulating the pound from much of the UK political wrangling right now,” Foley noted.
“That said, the pound could appreciate if strong leadership was restored in the UK,” she added.
Analysts at Pantheon Macroeconomics agreed, writing in a note today: “Investors generally favour Conservative governments, so sterling might rise a bit if Mr Johnson’s successor is judged to have a better chance of winning the next election. But the election likely will not be held until May 2024, beyond the horizon of many investors.”
This came with the caveat that the PM was unlikely to budge without the triggering of a leadership contest.
Would a new PM impact equities?
Russ Mould, investment director at AJ Bell, told Capital.com that leadership changes could move markets, pointing to investors welcoming Johnson’s election in December 2019 ahead of Labour’s Jeremy Corbyn (despite the Covid-19 pandemic sending the market crashing shortly after).
At present, markets will “wait to see who takes over, should the PM fall, and what their policy agenda looks like before they take a view,” Mould told Capital.com.
However, he added: “Either through inclination, response to public pressure or simply turns of events, the Conservative Party has taken a more interventionist line in the economy more generally and in certain industries specifically, such as fizzy drinks or gambling, media or utilities.
“That, and a colossal spending programme and surge in the cumulative budget deficit, may blur the lines between it and Labour, although probably not enough for the markets to abandon their apparent historical preference for a Tory government – the data shows that the FTSE All-Share has, on average, done better with a Conservative PM than a Labour one.
“A change in PM, if indeed there is one, could create some short-term volatility, depending upon who the new incumbent in 10 Downing Street turns out to be. But while political stability is welcome, there are many other factors at work when it comes to how the stock market performs.”
Read more: UK inflation rises to a 30-year high at 5.4% in December
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