Sterling traded below $1.22 on Monday and weakened against the euro, hurt by rising gilt yields and media reports of disagreements between the finance minister and his cabinet colleagues over the terms of Britain’s exit from the EU. The Daily Telegraph said Phillip Hammond could quit his post after he was excluded from government meetings because he criticised the “hard” Brexit stance of Prime Minister Theresa May. Although the Treasury denied that Hammond will quit, it did little to instill confidence in the pound, traders said.
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Sterling fell to $1.2172, having lost over 6 percent in the past two weeks after May raised the spectre of a “hard” Brexit where the government will negotiate for an exit that favours tighter immigration controls over free trade, likely curbing foreign investment needed to fund Britain’s huge current account deficit.
The euro was up 0.2 percent at 90.20 pence while trade-weighted sterling was at 73.9, not far from a record low of 73.4 struck last week. Speculators trimmed their net short bets against the pound in the week to Oct 11.
Traders said the selloff in gilts was hurting sentiment towards the currency. The 10-year UK gilt rose to 1.17 percent, trading near its highest since the June referendum.
“Investors are beginning to demand a higher premium for holding UK government debt because of two factors — the political uncertainty and risks about the economic impact of Brexit, and inflation expectations are rising on the back of a rapidly declining pound,” said Kathleen Brooks, research director at City Index, a local brokerage.
Speaking to the BBC, Bank of England deputy governor Ben Broadbent said the weakness in sterling could cause inflation to overshoot its 2 percent target but that tightening monetary policy would have “undesirable consequences”.
That was broadly in line with what Governor Mark Carney told a public meeting on Friday. Carney said he was willing to allow inflation to run “a bit” higher than the central bank’s 2-percent target to help employment and allow Britain’s economy to grow.
Inflation is expected to rise above 2 percent in 2017 because of a sharp fall in the value of the pound – a 16 percent tumble to record lows in trade-weighted terms.
At the same time, the economy is expected to slow as Britain begins the complicated process of leaving the EU and tries to negotiate new trade deals, leaving the economy facing a potentially toxic mix of a tumbling currency, rising bond yields, accelerating inflation and sluggish growth.
“Some seem to interpret these (surge in bond yields) as an early indication of capital outflows from the UK, which could escalate into a full-blown balance of payments crisis,” Credit Agricole said in a note.
But they added that with UK stocks rallying, it was unlikely that foreign outflows were gathering pace.
“This interpretation is further corroborated by anecdotal evidence from our recent meetings with clients in Asia. These confirmed that capital outflows from the UK and/or reserve diversification out of sterling are not an imminent threat.”