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Will The Sterling Hit Parity Against The US Dollar

| October 10, 14:16 GMT | By Zain Sheikh



Investors are now placing bets on the options market that the Sterling will keep tumbling until the end of the year, with several strategists saying there is an increasing risk of the currency hitting parity against the U.S Dollar. Cable was trading at the 1.3700 handle at the start of 2022 and is now valued at 1.0300, a 25% reduction. The large sell off is influenced by a combination of factors which include uncertain political decisions, spiking inflation, and a looming economic recession. It is likely that the market has not completely priced in a premium for the increased ambiguity for the months ahead. The following factors may possibly contribute to higher volatility in the GBP and justify parity.


Tax cuts

The catalyst for the Sterling crash started when Kwasi Kwarteng unleashed historic tax cuts and huge increases in borrowing. Liz Truss stood by her strategy and argued that it was essential to jolt the economy into higher growth. The criticism from her decisions compelled the repeal of her most 'eye-catching' move, the 45p top rate of income tax decrease. Despite this, people across the economic spectrum are expected to lose more than they gain. The freezes exceed the policies and are projected to push millions more into higher tax brackets. For example, a four-year freeze in the tax-free personal allowance of £12,570 means the number of income taxpayers would increase by 1.4 million to 35.4 million by 2025. During the same period, a freeze in the higher rate threshold will raise the number of people paying the 40p rate by 1.6 million to 7.7 million.

By 2025, the freezes will have reduced household income by £1,250 on average. The policy is a massive gamble that will have a long-term impact, with the tenth highest income families facing a 1.3% drop in income by 2030 and the lowest tenth seeing a 4.7% drop in income. Overall, the policies show a lack of confidence in their economic goal and a lack of confidence in themselves.


Gas Shortages

Due to the ongoing conflict between Russia and Ukraine, as well as a constraint of supply in Europe, the UK is expected to face substantial gas shortages throughout the forthcoming winter season. Although the UK is seen to be in a favorable position due to a little amount of gas purchased from Russia, rising tensions may push the UK to seek alternate sources. This is expected to result in higher costs and a greater difficulty for the UK in securing lower-cost gas supplies from other sources, given the potential impact of the Russia/Ukraine conflict on foreign suppliers.

The UK relies on gas-powered stations to generate 40-60% of its electricity. If a further reduction in gas supplies caused a disturbance, 'imbalance costs' would have to be paid. These chargers enable the National Grid to obtain power from other sources. If energy cannot be supplied, these expenses might escalate to £276 million. In the case of a supply shortage, gas supplies may be restricted to gas-fired power plants to guarantee that adequate supplies remain for UK homes to avoid blackouts. These effects were already apparent before Russia’s invasion of Ukraine, but the war has exacerbated them, and even with the guarantee, households and businesses will be worse off due to higher energy bills than they were a year ago, intensifying the problems associated with the cost of living.


Credit

On October 5th, Fitch Ratings downgraded the UK's sovereign credit rating outlook to 'negative' from 'stable,' although affirming the debt grade at 'AA-,' citing risks posed by the measures proposed in the chancellor's mini-budget. The Bank of England's outlook was likewise reduced to negative from stable by the agency. Fitch's decision reflects the "large and unfunded fiscal package outlined as part of the new government's growth strategy," which might "lead to a considerable increase in fiscal deficits over the medium term," according to the rating agency. According to the organisation, the UK's budget deficit will be 7.8% of GDP in 2022 and will rise to 8.8% in 2023 unless compensating measures are implemented.

As a result, the general government debt is expected to increase to 109% of GDP by 2024, up from a projected 101% in 2022, indicating greater primary deficits as well as a poorer growth projection. The United Kingdom's credit rating was last established at Aa3 with a stable outlook by Moody's. The UK's credit rating is AA (high) with a stable outlook, according to DBRS. In general, sovereign wealth funds, pension funds, and other investors use credit ratings to assess the creditworthiness of the United Kingdom, which has a significant influence on the country's borrowing costs.


To conclude, the US Dollar tale does not assist the Sterling to avoid parity. With the Federal Reserve continuing to raise interest rates, US Dollar based financial products continue to yield higher returns. The world economy is under severe strain, which increases flows into the ‘safe haven’ US dollar. Rising energy prices haven't struck the United States as badly. Despite the fact that its economy has declined in the previous six months, firms are still hiring, which is considered as a sign of continued optimism. The next handles to watch are 115 and 120 on the dollar index, which would result in cable approaching parity unless further intervention occurs.