Searing inflation in Britain driving pound near 37-year low

LONDON • It is starting to look like nothing can stop the British pound from sinking to new lows. With talk about inflation surpassing 18 per cent next year and families across the country likely to be pushed into energy poverty this winter, Britain's economic woes are getting worse by the day.

Traders' consensus is that the Bank of England (BOE) will have no choice but to force the economy into a severe recession and cause widespread job losses to rein in price pressures. That has put historic lows for the pound within reach.

The currency is trading around US$1.18, less than four US cents away from its weakest level since 1985 against the greenback, underscoring the challenges facing the British economy and the next prime minister.

The BOE is already forecasting a five-quarter recession starting later this year.

"Is there more downside? Yes, absolutely," said Mr Geoff Yu, a senior currency strategist at Bank of New York Mellon. "Even if things improve, sterling can't return to where it was in the past of US$1.40 or US$1.45. That's going to be very hard to achieve."

The surge in power prices is feeding through financial markets via higher inflation forecasts, leading traders to believe that the BOE will have to be more aggressive.

Money markets now show expectations for benchmark interest rates to rise 4.25 per cent next year, the highest since 2008. That drives up bond yields as well, with 10-year rates climbing to 2.59 per cent.

Theoretically, higher rates should lead to a stronger currency. But for Britain right now, it is the opposite.

The belief among investors is that further aggressive hikes in borrowing costs - needed to bring down price growth - would deepen Britain's economic malaise, leaving the country worse off compared with the US and the euro region.

"Rates aren't always going to be enough to support a currency when the growth-inflation trade-off is this bad," said chief currency strategist Kit Juckes at Societe Generale in London.

Britain's inflation rate hit a 40-year high of 10.1 per cent year on year last month, and Citigroup has said it could surge past 18 per cent in January.

More than half of British households risk being pushed into energy poverty this winter by soaring bills, according to consultancy Baringa Partners.

BLOOMBERG