by NGOC ANH 30/05/2022, 11:02

Will the UK's economic downturn put GBP in jeopardy?

It still looks very likely that the UK economy will fall into recession, or at least experience a period of extremely weak growth, despite the government’s GBP15bn fiscal package announced to ease the cost of living strain on households following the surge in energy costs, particularly gas.

The Pound will go down if the UK economy falls into recession.

>> Will the UK fall into a recession?

As argued many times before, the UK is in the most difficult position of all developed countries when it comes to tackling the problems caused by the conflict in Ukraine. In short, it faces the greatest risk of surging inflation and the greatest risk of recession. Now this might seem incompatible but, as has been pointed out many times, the UK faces the worst of all worlds with US-like labour market tightness risking a debilitating wage-price spiral, while EU-like vulnerability to surging energy prices creates the threat of very weak growth, if not a recession.

The government’s attempt to alleviate the strains via yesterday’s fiscal package will ease the pressure when household energy bills soar again in October. That will happen as the energy regulator, OFGEM allows energy suppliers to increase their charges (the cap) to customers. Beyond this, of course, households remain at the mercy of the wholesale gas market. Perhaps fortunately, wholesale prices have eased down and with OFGEM announcing recently that the cap will be altered every 3 months, instead of every 6-months, there is a chance that the January 2023 reset could see household bills fall, earlier than April 2023 under the prior rule.

However, the problem is that the multiplier effects from these one-off energy-relief payments could be quite low. Recipients seem more likely to save these sums (or at least that part not spent on higher energy bills) because the onset of winter will make consumers particularly wary that increased gas use could cause them to run through the government payouts pretty quickly.

But it is not just the surge in household gas prices that threaten a recession in the UK. For a start, there are other aspects of the energy price surge, such as the increase in petrol prices that will depress activity and raise business costs. We should also not forget that the government increased taxes back in April via higher national insurance charges, and consumers are just coming to terms with this increased burden. Food prices have also surged and here there’s no government fiscal relief. The government has been lobbied to make changes in Value Added Tax to ease strains in certain sectors where VAT is levied, such as restaurants, but clearly the government has not acted again following the temporary reliefs that were granted during the height of the pandemic.

>> Conundrum for the UK base rate

In addition, mortgage costs will likely rise further as the Bank of England lifts base rates again. All told, Mr. Steve Barrow, Head of Standard Bank G10 Strategy thinks that there are still plenty of reasons to be particularly pessimistic about growth opportunities in the UK even if the governments tax measures do help avoid a technical recession (meaning two consecutive quarters of negative growth).

Does this leave sterling at risk? Mr. Steve Barrow said the pound’s position would be not strong, but it seems likely that the market has discounted much of the economic weakness that is to come. “We also have to bear in mind that the sterling has been falling through the year in trade-weighted terms, leaving the pound looking particularly undervalued against the dollar. Another point is that the government is also getting on with many of the market opening/deregulation steps that it promised would happen after Brexit. In time, these could encourage inward investment to the UK and so help sterling reverse much of its undervaluation against the dollar. And it is not as if the US economy, or many other economies around the world are immune from their own risk of recession. In short, we don’t take the view that the pound is likely to get badly beaten up because of the UK’s ‘worst of all worlds’ position right now”, Mr. Steve Barrow stressed.