Deutsche Bank says risk of ‘sterling crisis’ rising as Trump becomes UK prime minister

A banner of Deutsche Bank is pictured in front of the DAX board, the German stock price index, at the stock exchange in Frankfurt, Germany on September 30, 2016.

Reuters

after the news Liz Truss will be the new Prime Minister of Britain, Deutsche Bank says that policy announcements in the coming weeks will be important if the UK is to avoid extreme macroeconomic events, notably the balance of payments crisis.

Truss won the race to succeed Boris Johnson as leader of the ruling Conservative Party on Monday after a drawn-out contest against former finance minister Rishi Sunak. Truss received 81,326 votes from members of the Conservative Party, while Sunak received 60,399 votes.

Sterling was partly higher against the dollar on Monday afternoon, trading just below $1.15, but Deutsche Bank FX strategist Shreyas Gopal warned that the risks of a “sterling crisis” should not be underestimated.

“As the current account deficit is already at record levels, Sterling needs large capital inflows to improve investor confidence and lower inflation expectations,” Deutsche Bank said in a note on Monday. However, the opposite is happening. Is.”

“The UK is suffering from the highest inflation rate in the G10 and a weak growth outlook. A large, unfunded and untargeted fiscal expansion is accompanied by potential changes. bank of englandThe U.S. mandate could lead to an even higher rise in inflation expectations and – at the extreme – the rise of fiscal dominance.”

Truss firmly put the Bank of England and its governor, Andrew Bailey, in the crosshairs during his leadership campaign, blaming the central bank for allowing inflation to climb to a 40-year high, and allegedly undermining the bank’s mandate. Considering review.

She has also suggested scrapping the Northern Ireland Protocol, a key part of the post-Brexit agreement between the UK and the EU, a move that is likely to lead to retaliation from the bloc.

Gopal suggested that additional uncertainty over trade policy would worsen the macroeconomic picture and dent investor confidence.

“The risk premium on UK gilts is already rising, coinciding with unusually large foreign outflows. If investor confidence further erodes, this dynamic could become a self-balancing of payments crisis that could lead to foreign UK gilts. Will refuse to fund external deficit,” he said. ,

Deutsche Bank estimates that trade-weighted sterling – a measure of the pound’s value against selected currencies most important for international trade – would have to fall below 15% for the UK deficit to return to its 10-year average.

“The balance of payments crisis may sound extreme, but it is not unprecedented: a combination of aggressive fiscal spending, severe energy shock, and a slide in sterling eventually resulted in the UK resorting to IMF loans in the mid-1970s.” Gopal said.

“Today, the UK retains some key lines of defense against abrupt halts, but we worry that the risks continue to mount.”