The pound jumped as UK prime minister Boris Johnson announced his resignation, but analysts warned the turbulence was far from over against a backdrop of intensifying political uncertainty and economic headwinds.
Sterling rose as much as 0.8 per cent against the dollar on Thursday after a chaotic two days in which more than 50 government ministers quit. Sterling hit a high of $1.2023 and also reached a four-week high against the euro, at €1.173.
While the pound reacted positively to the announcement of Johnson’s resignation, investors are now weighing up the future of the UK’s economic leadership and plans to tackle inflation, which is running at a 40-year high. Inflation has raced higher in the UK, driven by surging food and energy prices triggered by Russia’s war in Ukraine, which has left Europe scrambling to source new oil and gas supplies and facing the threat of recession.
Meanwhile, economic output is forecast to have slipped 0.3 per cent in May from the previous month in the third straight monthly contraction, according to a FactSet poll of economists.
Guy Foster, chief strategist at Brewin Dolphin, said Johnson’s resignation does little to change the UK’s economic trajectory in the short term, and the subsequent outlook of sterling. “It’s really hard for investors to see that there is a material change in economic policy coming any time soon . . . At the very least, there’s going to be weeks of Conservative leadership contest and in the meantime, really not much changes.”
A powerful and broad rally in the US dollar this year as the Federal Reserve has rapidly hiked interest rates has also weighed heavily on sterling and many of its peers. The pound is down 11.5 per cent against the greenback in 2022, slightly worse than the euro’s 10.3 per cent slide.
Jordan Rochester, strategist at Nomura, said that the jump in sterling on Thursday was a “dead cat bounce” — when currencies briefly rise after a prolonged downturn — as investors took profits.
“I would see rallies as opportunities to sell given the prevailing economic malaise,” added Tim Graf, head of Emea macro strategy at State Street.
Investors are keenly watching potential Conservative party leaders’ economic policy views for hints about how to improve growth.
Chancellor Nadhim Zahawi, who was appointed by Johnson on Wednesday and on Thursday urged him to quit, said he would review current plans to raise corporation tax. “I think that’s very minor for sterling,” said Rochester, adding that “we face a consumer confidence crisis [and] a consumption squeeze.”
The prospect of a more hardline Brexiter in charge is likely to be detrimental to the pound, analysts said. Steve Baker, former head of the European Research Group, has signalled that he would run for prime minister.
The Office for Budget Responsibility on Thursday knocked the hopes of potential Conservative leadership candidates planning to instil tax cuts, saying that the UK’s public finances are already “on an unsustainable path in the long term”.
“There’s not a huge amount of room for manoeuvre,” said Foster. “Almost any other Conservative leader is likely to be more fiscally prudent than the one we’re in the process of saying goodbye to.”