Recession Unease Sends Pound Crashing to Worst Quarter Since ’08

(Bloomberg) — In the words of AllianceBernstein economists this week: “The UK economy is being pulled apart.”

The evidence is everywhere. Households are losing their spending power, the cost of basic goods is skyrocketing and business confidence is dismal. The pound is coming off its worst quarter since 2008 and sank below $1.20 on Friday. 

While economic reports are pointing to a downturn worldwide, the UK’s position appears especially precarious. Goldman Sachs Group Inc. puts the probabilities of a UK recession at 45% in the next 12 months, compared with 40% for the euro-area and 30% for the US. 

That bleak picture is keeping investors away from British assets and bringing a halt to M&A activity. Nomura Holdings Inc.’s currency strategist Jordan Rochester has been urging clients to short the pound with a bet that it will fall to $1.18 by early August. 

“It is too early to believe the pound is cheap enough to recover without some improvement in the UK growth outlook,” said Neil Weller, head of global FX strategy at JPMorgan Asset Management.

Here’s a snapshot of what’s happening in UK markets:

Pound Sterling

The pound weakened 7.3% against the dollar during the second quarter and is trading near levels seen during the depths of the Covid pandemic. “Boris Johnson’s leadership is in doubt and longer-term ideas such as an independence referendum for Scotland next year may weigh on investment flows,” wrote Rochester of Nomura. 

UK Stocks 

The blue-chip FTSE 100 Index has held up better because of its large weighting to energy producers and banks. Still, strategists are starting to highlight worries on the horizon. “Recession is a risk to all equities and FTSE 100 does have some large-cap consumer names that would be sensitive,” wrote Goldman strategists led by Sharon Bell. The FTSE 250 Index, a benchmark of UK midcap stocks, plunged almost 9% in June.   

Corporate Debt

UK junk bond yields have topped 9%, the highest since 2020 and more companies are dipping into distressed territory. A note issued to back a private equity takeover of Asda is trading at 77 pence on the pound.

Gilts Market

The search for safety has pushed investors back into the bond market. Two-year gilt yields, fell 16 basis points on Friday to 1.68%, the lowest in a month.

Next Week

• European Central Bank President Christine Lagarde is due to speak next in France on July 8 at the end of a long slate of scheduled appearances by officials next week. Policy makers are preparing to hike rates for the first time in over a decade later this month with inflation at the highest on record.
• Strategists at Citi expect about 23 billion euros ($23.9 billion) of supply from sovereign issuers, including Austria, Germany, France and Spain. The ECB stopped buying net asset purchases under the APP as of July 1.
• Traders will look to speeches from Bank of England officials, including Huw Pilland Jonathan Cunliffe in the absence of a July policy meeting. On Friday, traders pared bets on the pace of BOE rate hikes, pricing less than 150bps of tightening by year-end for the first time since June 7, as concerns mount over the health of the UK economy.
• Economic numbers next week include French and German industrial output and Dutch CPI.