Pound in Freefall Hurts U.K. Bonds as Goldman Sees More Losses

  • Sterling drops to new 31-year low as Brexit concerns intensify
  • Gilts tumble as bond market’s inflation expectations climb

The Long and Short of a Falling Brexit-Bruised Pound

The shadow of a hard Brexit is spreading across Britain’s financial markets, with the pound’s drop to a 31-year low versus the dollar leading the way.

Government bonds also slid as the weaker currency boosted the market’s inflation expectations. Even stocks, which have thus far been buoyed by sterling’s drop, couldn’t escape the selloff, with the FTSE 100 Index dropping for a second day.

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Leaving the EU has been the main topic at the ruling Conservative Party’s annual conference this week, where U.K. Prime Minister Theresa May seemingly moved closer toward a so-called hard Brexit that would restrict access to the European Union’s single market so that the government can control immigration. Sterling has tumbled more than 2.5 percent since May’s speech on Sunday, accelerating losses as she was said to take the view that financial services would get no special favors in EU exit talks.

With March now set as the deadline for triggering divorce proceedings, tensions are playing out in the currency market. The pound has already dropped 15 percent since the referendum to leave the world’s biggest single market, and is 2016’s worst-performing major currency. Companies including Goldman Sachs Group Inc. and AllianceBernstein Holding LP have issued predictions for more pain ahead.

“There’s been a sea change in the sterling market,” said Jane Foley, a senior strategist in London at Rabobank International, which predicts a drop to $1.25 by mid-2017. “Suddenly, with March on the horizon, we’re beginning to see some of the risks associated with Brexit coming into full focus. The market is more worried now about the future than the present.”

Leading Selloff

The rally of the previous day seemed long-forgotten as the pound fell 0.9 percent to $1.2641 as of 4:07 p.m. in London, having slumped to $1.2622, the lowest since 1985. It sank 0.5 percent to 88.32 pence per euro, after reaching a five-year low.

That slide is fueling bets on faster inflation, with the 10-year break-even rate, a gauge of expectations for retail inflation over the next decade, climbing to the highest since 2014 this week.

Faster inflation reduces the value of fixed-payments linked to bonds, and may also deter the central bank from more interest-rate cuts or asset purchases, further reducing the allure of U.K. securities. The final part of the picture is the prospect of a loosening of fiscal policy by new Chancellor of the Exchequer Philip Hammond, who hinted at more infrastructure spending in a Bloomberg Television interview on Thursday.

Benchmark 10-year gilt yields rose seven basis points, or 0.07 percentage point, to 0.88 percent, after touching 0.91 percent, the highest since Sept. 15. The 1.5 percent security due in July 2026 dropped 0.64, or 6.40 pounds per 1,000-pound face amount, to 105.795.

“The move in gilts is leading bond markets in general,” said Jeremy Stretch, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London. “The fiscal backdrop is surely set to worsen into 2017.”

While sterling’s weakness has become a focus of politicians who opposed the “Leave” referendum campaign, it’s not necessarily bad news for everyone, with the lower exchange rate potentially cushioning the economy by helping exporters. The currency’s losses had pushed the FTSE 100 close to a record this week, a relationship which faded on Thursday as the index dropped 0.4 percent.

Sterling’s losses may not be over. AllianceBernstein, which oversees about $490 billion, predicts the pound could tumble as much as 17 percent to $1.05-$1.10, while Goldman Sachs forecast a slide to $1.20, with the risk of even greater losses because of concerns over Brexit.

“Investors fear the U.K. economy may move into recession post-Brexit,” said Neil Jones, head of hedge-fund sales at Mizuho Bank Ltd. in London. “A school of thought is building to suggest this over the last 24 hours, and looks to be weighing on the pound.”

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