FX Spotlight | GBP: Monetary and fiscal pressure | Article – HSBC VisionGo

GBP: Monetary and fiscal pressure
Finance  ·    ·  6 mins read

  • The UK government’s new levy takes its overall tax burden to historical highs…
  • …and the recent comments from the two BOE policy makers appear to be less hawkish
  • All these forces help to cement our expectation of a lower GBP-USD

The GBP is facing some downward pressure amidst headlines from two Bank of England (BOE) policy makers and potential tax hikes by the UK government to pay for health and social care. We have long argued that GBP-USD should be lower and these forces help to cement that thinking. 

Our economists think that the overall UK fiscal stance will be negative

On taxes, the UK government has announced a new Health and Social Care levy – comprised of an increase of about 1.25% in National Insurance (i.e., a tax paid by workers and employers) to raise GBP11.4bn (apart from an additional 1.25% increase in dividend tax to raise GBP0.6bn). In our economists’ view, the new planned tax rises for 2022, alongside the corporation tax hike in 2023, will take the UK’s tax burden to historical highs, and so while the latest measures are technically fiscally neutral, with revenues matched by new spending on health and social care, the overall fiscal stance will still be negative and the ‘real feel’ for households and businesses could be painful. 

A tax hike, risking a weaker UK growth outlook into 2022, would weigh on the GBP, in our view

One of our concerns for the GBP has been how the UK economy would hold up once the UK government support rolls off in the second half of the year. But a tax hike would be an even more direct hit to the economy, especially as it would fall more prominently on younger and lower income workers who tend to have a higher propensity to consume. This risks a weaker UK growth outlook into 2022. 

The recent comments from the BOE policy makers suggest that the rate hike may come later and slower than what the market currently has priced

This then brings us onto the BOE and the rate hike profile. While quantitative easing (QE) looks likely to run its course this year, the big question is when and how quickly the BOE’s monetary policy committee (MPC) will hike. Comments from MPC members Michael Saunders and Catherine Mann suggest that risks are skewed to being later and slower than the market currently has priced (around 25 basis points higher than the current level by the middle of 2022, Bloomberg, 7 September 2021). Ms. Mann, a new appointee to the MPC, showed little concern about a return to a 1970s inflation spiral in comments made on Monday (Bloomberg, 6 September 2021). Meanwhile, Mr. Saunders, considered a hawk for voting to end QE sooner, suggested that hikes may happen “in the next year or so” but that any rises would be limited due to the fall in the neutral rate in recent years. 

All this suggests a lower GBP-USD, in our view

The GBP was the second outperformer in H1 among G10 currencies (only lagging behind the CAD), and, if anything, appeared to price in a more optimistic scenario compared to rate pricing during this period. Risks to the downside are now building from this excessive exuberance, in our view.

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