By Nick Hedley
The U.K.’s economic and political crises are increasing the
risk of a “collapse” in the value of the British pound, which could move close
to parity with the dollar, according to Bank of Singapore’s chief economist, Mansoor
Mohi-uddin.
From trading around $1.37/£ in mid-January, the pound has
been steadily weakening as inflation surges, recession fears build, and industrial
pay disputes worsen.
On August 26, it was trading at $1.18/£,
but Mohi-uddin said it could still slide to levels last seen in the mid-1980s
if any further shocks materialize.
“A sudden loss of investor confidence now could see a test
of its all-time 1985 low of $1.05,” he said in a research note.
The U.K. is currently grappling with double-digit inflation
owing to pandemic disruptions, the gas crisis, and trade frictions linked to Brexit.
According to Bank of England (BoE) forecasts, inflation is
set to hit 13% when household energy bills are reset in October. But that could
be a conservative estimate if Russia continues to throttle gas supplie, Mohi-uddin
said.
Partly because of this, Bank of Singapore expects the U.K.’s
economy to shrink 0.6% in 2023.
Mohi-uddin said ongoing disputes over pay increases pose
another risk, as does the poor state of public services, including the National
Health Service, which have been underfunded in recent years.
Meanwhile, disputes with the EU following Brexit are weighing
on trade “and may result in a costlier confrontation over Northern Ireland’s
exports.”
Despite these risks, the government “seems paralyzed” as the
ruling Conservative Party elects a new leader to replace Prime Minister Boris
Johnson.
Bank of Singapore expects another 100 basis points of
interest rate increases by the end of the year.
“But interest rate hikes may not be enough to prevent a GBP
collapse,” Mohi-uddin said. “For example, the BoE may be forced to pause its
tightening by year-end if Russian gas supplies to Europe are fully cut off and
the U.K. falls into recession.
“With the U.K. current account deficit at a staggering 8% of
GDP, the GBP is highly vulnerable to capital inflows drying up.”
Nicholas Fawcett, vice president of the BlackRock Investment
Institute, said in a research note that considering where inflation is now, the
level of activity the U.K. economy can comfortably sustain is probably 5-6%
lower than it would have been without the pandemic.
For context, that is the equivalent of Manchester,
Birmingham and Bristol – three sizeable U.K. cities – no longer producing
anything at all.
The U.K.’s production problems stem mainly from a low labor
supply, with many firms struggling to fill vacant posts, according to the
report, which was co-authored by Alex Brazier, deputy head of the BlackRock
Investment Institute.
“The only way to have avoided an inflation problem would
have been to choke off the economy’s restart from the pandemic shutdowns much
earlier,” Brazier said.
“Having not done that, the Bank of England, like the Federal
Reserve, is between a rock and a hard place. It must now either slam economic
activity down with a deep recession or live with persistent shortages and broad
inflation pressures.”