Global | Monetary Policy & Inflation | UK
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Summary
- GBP implodes after the UK chancellor announces extensive stimulus.
- We avoid trading it against the dollar.
- Instead, we open a tactical short EUR/GBP.
It Began With a Bang
The UK chancellor’s extensive fiscal package stole the show last week. It includes a large rise in immediate spending to cover an energy price cap freeze and more long-standing deficits from tax cuts. However, the debt funding for the plan, and the concentration of gilt issuance in the short end (<7Y), was a surprise. The market reacted badly, with GBP and UK bonds selling off sharply (Chart 1). Pricing for a BoE hike jumped to 150bp by the end of November’s meeting, with a 6% terminal rate now priced.
Trading GBP Against the Dollar?
Following the event, we expressed caution about extrapolating GBP weakness from here against the dollar. For one, on a real basis, GBP/USD is close to the post-war lows seen in 1951 and 1985. We need to go back to the late 1700s and early 1800s to see the currency pair weaker (Chart 2). Moreover, much of general GBP/USD weakness is as much to do with dollar strength as sterling weakness. This month, the Norwegian krone has dropped 7.5%, NZ dollar 7% and Swedish krona 6%; all are comparable moves to GBP.
Trading GBP Against the Euro
GBP looks attractive, but the prospect of more dollar strength could push all currencies lower, so we prefer to be bearish EUR/GBP. Short term, the marginal newsflow on the UK fiscal picture is unlikely to worsen. Consensus has dubbed it an EM-style action, and the BoE has rejected an intra-meeting move. Moreover, much of the UK-specific weakness appears to exhibit flash-crash dynamics. History suggests fading such moves tends to be profitable. Finally, our short-term value/correlation models for EUR/GBP show the most correlated driver, euro real yields, suggests a lower EUR/GBP (Chart 3).