Sterling’s woes, Kwarteng’s vows, Bailey in the middle

The negative market reaction to last week’s fiscal announcements appears to be a function of doubts over the credibility of the UK government’s long-term fiscal plans. Though we think the structural position is not as bad as last Friday’s drop in asset prices implies, it’s clear the government will struggle to retain credibility if it fails to engage with market concerns.

What you will learn:

• The BoE has a key role to play in supporting sterling. We don’t expect an emergency rate hike, but Governor Bailey is likely to verbally commit to further aggressive rate hikes. This adds upside risk to our forecast that Bank Rate will reach 4% in early-2023.
• The structure of the UK’s external assets and liabilities means fears of a sterling collapse are overdone, in our view. But sterling will remain volatile in the short-term and, though heavily undervalued, a sustained recovery is unlikely until the government has regained its credibility with markets.