As the numbers sank in, sterling fell to a fresh two-year low, before recovering slightly on Friday. But the risk of UK stagflation – the ghastly combination of soaring inflation and economic stagnation, last seen in the 1970s – now looms large. That’s why some traders predict the first sustained drop in sterling below $1.20 since 1985.
And given how quickly the pound has fallen over the past month, there is even open discussion the UK currency could soon collapse to near-parity – with one pound equaling one dollar.
Sterling is under pressure in part, of course, due to the strength of the US currency – which last week climbed to a fresh 20-year high, amid concerns central bank actions to tackle inflation across the world will flatten global growth, boosting the dollar’s appeal as a safe haven.
US inflation actually fell slightly, we learned last week, to 8.3pc in April, from 8.5pc the previous month. As a world-leading producer of both food and energy, America is far less exposed than Western Europe to the economic fallout from war in Ukraine.
Since the start of the year, the dollar has anyway benefited from “flight to quality” investment flows, as reasons to be nervous have mounted – the impact of the omicron strain and the re-emergence of China’s zero-Covid restrictions dampening growth in the world’s second-largest economy, as well as war in Ukraine.
It’s noticeable, though, the pound has lost ground since mid-April, not just against the dollar but to other currencies too, with sterling down about 3pc against the euro.
Britain was meant to be in the midst of a post-lockdown bounce-back by now, with the official 2022 GDP growth forecast up at 6pc as recently as late March. Less than two months on, Britain is heading for the slowest growth and the highest inflation of any G7 economy – amidst rising political uncertainty. As far as the currency markets are concerned, it’s an unattractive combination.
The recent sell-off in sterling came despite the Bank of England’s monetary policy committee raising interest rates earlier this month, for the fourth time in as many meetings, from 0.75 to 1pc – the highest level in 13 years. A rate rise generally makes a currency more attractive given the higher return – but sterling plunged.
The reason was that the markets had been expecting an increase not of 25 but 50 basis points to 1.25pc – along with a strong signal of many more rate rises to come.
Yet Governor Andrew Bailey and his team didn’t deliver that, while also failing to signal the beginning of attempts to rein in the Bank of England’s massively expanded balance sheet – so called quantitative tightening, countering at least some of £875bn of quantitative easing we ‘ve seen since the 2009 global financial crisis. Half of that massive monetary expansion has come since the Covid pandemic, being used in part to pay for furlough, business support loans and other lockdown-related measures.
The reality is that financial markets are now unclear whether the Bank of England cares more about tackling inflation – which is meant to be its mandate – or pandering to avoiding recession. After all, Bank officials spent months denying inflation was a serious problem, referring to UK price pressures as “transitory” even towards the end of last year – months after break-even spreads and other markets signals were warning inflation was set to soar.
That’s why, as this column has often observed, the Bank’s credibility is now seriously in question, along with its broader independence.
And, at times of crisis, that lack of credibility really matters.
Sterling is now at risk of falling into a “doom loop”, given that a lower pound results in more expensive imports, adding to upward price pressures. The resulting rise in inflation then pushes the pound down even more, creating a downward spiral.
The UK is particularly susceptible to this danger, given high dependence on imports. During the first quarter of this year, the trade deficit of goods and services widened from £14.9bn to £25.2bn, according to last week’s official data.