The Pound "Shouldn't be Haunted by the Ghosts of 2022" Says Deutsche Bank

Above: Image © Pound Sterling Live, original picture by Simon Dawson / No 10 Downing St.

On the eve of the UK budget, a Deutsche Bank analyst tackles the question of whether GBP investors ought to fear the return of the "bond vigilantes" and a repeat of the 2022 episode that saw UK bonds, FX, and stocks all materially weaken.

"This time is different, and that things ought to remain much calmer this year," says Shreyas Gopal, Strategist at Deutsche Bank in a note released ahead of Wednesday's budget announcement.

Pound Sterling and UK bonds cratered in September 2022 when newly installed Prime Minister Liz Truss attempted to push through sweeping tax cuts and spending commitments without regard to the outlook for UK finances.

The selloff in bonds signalled investors were concerned the UK risked being unable to pay its debtors, prompting the Pound to fall to multi-year lows against the Euro and Dollar.

But according to Gopal "Sterling's external vulnerabilities screen much lower now helped in no small part by the fall in energy prices."

He explains that in August 2022 the UK was spending much as 4% of GDP on net energy imports and then in early September Truss committed to a potentially unlimited USD import bill through the Energy Price Guarantee scheme.

"Not only is the current account in a better position, but the Bank of England are no longer seen as a dovish outlier, providing the pound with adequate yield support," he says. "While we were quite worried about the risks to sterling from fiscal policy ahead of the mini-budget crisis in 2022, we currently don't see the same kind of negative tail risks for sterling this time around."

Looking beyond the budget to this year's General Election, the Deutsche Bank analyst says the most likely scenario is that there's little spillover to the pound from politics, with the bar much higher to our mind than eighteen months ago.

"To be sure, with implied vol this low - especially in EUR/GBP - there may be value in cheap tail risk hedges, but for spot FX we continue to favour GBP higher. Our preferred expression remains long GBP/CHF, now up over 5% YTD inclusive of carry," says Gopal.

Above: UK (net) fuel imports had reached 4% of GDP in August 2022.

This year's election will differ from previous elections in that both parties have signalled a strong commitment to prudent management of the country's finances, with the Labour Party marking a departure from the Jeremy Corbyn era.

The party has cast itself as being pro-business, which makes for a relatively low-risk environment for businesses looking to invest.

Meanwhile, UK business investment has grown faster than any G-7 nation since the government introduced tax relief on investments in April 2021.

Should pro-business policies be expanded on by the next government, sentiment towards the Pound can improve.