UK finances shape sterling outlook

The current BoE emergency bond-buying program will end on Friday. The Bank of England is preparing to increase the size of its daily purchases of government bonds to ensure there is enough capacity to buy bonds before it ends on October 14. The Bank of England's speech this week may prompt the market to reduce expectations of its rate hike, and the pound may fall in the future.

The central bank said the maximum size of each bond-buying operation would be confirmed each morning and set Monday's bids at a maximum of 10 billion pounds ($11 billion). The measures are "to support an orderly exit from its buying plans, including preparations to increase the size of daily auctions."

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The market is pricing in a rate hike of nearly 100 basis points for each of the next three Monetary Policy Committee meetings. While this "seems acceptable data" for the November meeting, a BoE spokesman is unlikely to endorse the market's long-term pricing.

GBP/USD will edge lower towards 1.1 as downside risks remain high. Prime Minister Truss will try to reconcile with the different factions of the Conservative Party. Markets will be watching closely to see if this leads Truss to abandon her other fiscal views (like a windfall tax on energy companies). The state of the UK's finances remains the key to sterling's moves. Sterling fell after ratings agency Fitch on Wednesday downgraded the outlook on the credit rating of Britain's government debt to "negative" from "stable".

Combined with the view of a stronger dollar, GBP is expected to easily break below the 1.1 support level soon and remain in a downtrend over the next year. UK employment data will be the focus of the week, with the unemployment rate expected to edge up again.

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UBS said that the UK faces political challenges, and the pound may continue to struggle in the short term. Although the pound has obvious upside potential, it is recommended to reduce exposure to the pound given the current low value of the pound; given the concerns about fiscal policy, the sterling's downside The potential is also high.

Fitch: The UK economy is likely to decline further as interest rates accelerate. UK GDP is now forecast to fall by 1% in 2023, compared with a 0.2% drop expected in September. UK policy rates are expected to rise faster. The UK economy is expected to enter a recession from the fourth quarter of 2022 due to the compounding effects of rapid rate hikes, the euro zone energy crisis and economic contraction. The UK policy rate is now expected to rise from 2.25% to 4.25% by December 2022, before rising to a lower-than-consensus 5.0% by the second quarter of 2023.