UK recession may deepen

According to economists' forecasts, the expected scale of the Bank of England's upcoming interest rate hike will deepen the British recession. Markets expect the Bank of England rate to rise to 5.5% and interest rates to only rise to 4%, which will lead to a depreciation of the pound.

Dales, chief U.K. economist at Capital Economics, said he now believes the U.K. recession will deepen further due to the expected size of the Bank of England's upcoming rate hike. If interest rates rise from 2.25% to 5.00%, as we now expect, we think the economy will suffer a deeper recession, including a peak-to-trough decline of 2% in real GDP.

Sterling should resume its weak trend after Prime Minister Truss dampened expectations for further adjustments to fiscal policy. Truss confirmed on Wednesday a 180-degree reversal of plans to repeal the top income tax rate, but said the government would move forward with other tax cuts. Without further fiscal tightening, Britain will face higher government bond yields that will undermine an already weak economic growth outlook. Now that the dust is starting to settle after the pound’s recent wild swings, the bear market trend in the pound is expected to resume.

Sterling was among the G10 currencies that fell the most in the second quarter, although the yen, euro, Swedish krona and Norwegian krone also fell sharply. If changes are measured in terms of the proportion of foreign exchange reserve allocations, central bank official savings investors increased their holdings of US dollars and Canadian dollars during the best-performing period in the G10. The dollar's share of foreign exchange reserves rose from 58.85% to 59.53% in the second quarter, although more than $500 billion was sold during the period, possibly as central banks tried to protect their currencies from a stronger dollar .

Adding to the pressure on the pound, data showed that private sector economic activity in the U.K. fell by the most since early 2021 in September. Sterling's rally is likely to continue in the short term, but long-term upside potential for the pound may be limited until political, economic and fiscal risks become clearer.

The new Prime Minister Truss has announced the largest package of tax cuts since the 1970s, including scrapping plans to raise corporate tax to 25% and lowering the tax rate for individuals earning more than £150,000 a year from 45% to 40% %, slashing home purchase taxes and removing caps on bankers' bonuses, aiming to bring the UK from the brink of recession back to pre-pandemic levels. British Chancellor of the Exchequer Peter Kovalten said that "in a new era, we need a new way to focus on growth", but worried investors did not buy it, and the pound fell sharply to its lowest level in history.