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Beleaguered sterling heads into a perfect storm

Olga Cotaga and Ritvik Carvalho
An English ten Pound note is seen in an illustration

By Olga Cotaga and Ritvik Carvalho

LONDON (Reuters) - Sterling is beset by woes.

The currency is struggling near its lowest levels in more than three decades, and a Brexit trade deal looks distant. Meanwhile it is grappling with the prospect of negative interest rates in Britain, a deep recession and a growing pile of debt.

Talks between Britain and the European Union to nail down a trade deal have not gone well so far, with the clock ticking on a Brexit transition period that runs out at the end of the year.

As if a potentially messy exit was not enough, the Bank of England could conceivably push interest rates below zero to aid an economy that is facing its deepest recession in decades.

Investors are rattled, and hedge funds have ramped up bearish bets on the pound.

"Unless Boris Johnson's government can come up with a coherent post-Brexit plan, the pound may be vulnerable from these already low levels," said Stephen Jen, co-founder at hedge fund Eurizon SLJ.

Below are a series of charts indicating why the pound is likely to weaken further.


1) MONEY MARKETS IMPLY NEGATIVE RATES

While the Bank of England's chief economist Andy Haldane said the central bank was not even remotely close to implementing negative rates, money market futures from March 2021 are already pricing in such an outcome.

Graphic: UK interest rates skirt zero level - https://tmsnrt.rs/3c9LgaV


2) VALUATION AND POSITIONING

Graphic: FXvaluations - https://tmsnrt.rs/2ZADBji


Though the pound remains one of the most undervalued currency on a trade-weighted basis adjusted for inflation, along with its Scandinavian counterparts, it is still among the most shorted currencies in the $6.6 trillion a day FX markets.

Latest positioning data in the week up to last Tuesday showed speculators are holding a sizeable $1.5 billion net short position against the pound.

Graphic: Short positions stack up against pound - https://tmsnrt.rs/2B776z4


3) ECONOMY

The collapse in UK economic activity is not out of line with its peers. Nonetheless, Britain's economy shrank by a record 5.8% in March.

Graphic: G4 GDP growth - https://tmsnrt.rs/2LZCB0a


The British economy is more vulnerable than some because it does not have the support of a large current account surplus like that of the European Union. Nor does it have the powerful reserve currency status of the U.S. dollar.

Graphic: Mind the gap: UK current account deficit - https://tmsnrt.rs/36zKtPj


4) DEBT

Britain's debt mountain exceeds $2.5 trillion and its public sector net borrowing is on course to reach 14% of gross domestic product this year, the biggest single-year deficit since World War Two. A measure of British public debt jumped to close to 100% of the country's economic output in April, its highest in nearly 60 years.

Graphic: G4 government debt - https://tmsnrt.rs/2X5r8lR



(Reporting by Olga Cotaga; Graphics by Ritvik Carvalho; Editing by Saikat Chatterjee and Pravin Char)