FX: The best-performing G10 currencies are also facing a lose-lose situation

As the best performing G10 currency against the US dollar this year,GBP/USDIt has risen by more than 5%.This dazzling performance is mainly attributed toThe Bank of England has raised interest rates 14 times in a row, and the market expects it to continue raising interest rates.

The Bank of England is likely to be the last major central bank to pause its rate-hiking cycle, and even if inflation is eventually contained, it may be the last to start cutting rates.

Markets are now all but certain that the Bank of England will raise interest rates for the 15th time at its September 21 meeting, with even more expected in the future, according to sterling money markets.Futures contracts now expect three more rate hikes of 25 basis points each, with rates peaking at 6% in March.

Interest rate spread support is unsustainable

However, the pound needs to beware of a turning point, when,Its strong performance cannot be supported by wider spreads alone, but must be backed by a strong economy.

With the UK's economic output flat, the pound can still hold its ground against currencies in other low-growth regions such as the euro, but it is unsustainable compared with currencies backed by strong economic performance, such as the dollar. As the gap with the Bank of Japan's still negative base rate widens,GBP/JPYIt is up 15% this year. But with Japan's economy growing at an annual rate of 6% in the second quarter, it will be difficult for the pound to remain strong against the yen.

Audrey Childe-Freeman, chief G10 foreign exchange strategist at Bloomberg, said:The pound is in a lose-lose situation.She pointed out that CFTC data shows that,Investors who had previously increased their holdings of sterling began to sell off.Warning signs abound, with UK 10-year yields, for example, hovering around 45 basis points above US Treasuries and more than 200 basis points above German Bunds.The cost for the UK to finance its 2.30 trillion pound debt is much higher,And the debt level has exceeded 100% of GDP.

The economic downturn will weaken the pound

Inflation in the UK is now higher than in most developed countries, with services inflation accelerating at a record 7.4 per cent and consumer prices hard to contain. Full employment kept the economy humming during the pandemic and subsequent cost-of-living crisis, but unemployment jumped from 3.8 per cent to 4.2 per cent in just two months. The Bank of England had not expected the unemployment rate to rise to this level for another year.

The Bank of England's August policy report highlighted the need for private sector wage growth to slow to close to 6 per cent by the end of the year as a prerequisite for easing monetary tightening. July employment data showed the measure climbing further to 8.2 per cent.This makes further interest rate hikes inevitable.However, the July retail sales report released on August 18 was weaker than expected.It shows that the economy is clearly being affected.

The Bank of England does not expect a recession in the coming months, but acknowledges that risks are growingBloomberg Economics forecasts that UK GDP will contract in the fourth quarter and continue to decline in the next three quarters, with full-year GDP falling by 1%. Meanwhile, eurozone growth is expected to strengthen modestly.

When the economy turns downward, it can affect the currency in a number of ways, particularly if the economy alters the trajectory of the Bank of England's interest rates.If the hawkish stance of the central bank weakens, the support of the pound will collapse.

FXTForeign exchange investment indicates that barring a dramatic turnaround,Britain will face a long period of stagflation, with little economic growth and persistent inflation.In this context, the pound can only hope that the dollar's decline accelerates if it is to remain strong. However, hope has never been a strategy, whether in life or in currency transactions.