The strength of the US dollar, supported by the expectations of raising US interest rates throughout 2022, and the classic political collapse of the Boris Johnson government was a strong motivation for the bears to push the price of the GBP/USD pair to collapse towards the 1.1875 level. This is the lowest support level for the currency pair since the markets collapsed at the height of the Corona epidemic in March 2020. Boris Johnson's resignation as British Prime Minister contributed to a cautious recovery of the pound sterling against the dollar towards the level of 1.2056 before closing trading around the level of 1.2016. Overall, according to experts, the UK market's indifference to the overthrow of Prime Minister Boris Johnson may change quickly.
Johnson's ouster has increased the odds of an early general election, according to market analysts at NatWest Markets and Citigroup Inc. and Mizuho International Plc. It opens the door to a spending spree to lure voters before they head to the polls, followed by the prospect of the opposition Labor Party coming to power and paying more cash.
It will affect everything from Bank of England policy and taxes to sterling, bonds and stock markets - and will also see past risks resurface like another Scottish independence vote and the reopening of BREXIT negotiations. Although there are still a lot of terms and conditions, the election is already permeating the minds of investors.
For their part, said NatWest analysts including Imogen Bachra: “The probability of the election itself will be unequivocally negative for the currency with the escalation of broader political risks.” Acting “strongly” in the second half of 2023 and higher long-term bond yields.
And after three turbulent years in office, Johnson's reign appears to have come to a chaotic end after the mass resignation of members of his cabinet last week. His Conservative Party is urgently making plans for an accelerated contest to choose his successor this summer. The next election won't be until January 2025 at the latest, and Johnson's successor will not be obligated to return to the polls before then. However, they may be tempted to take advantage of any political honeymoon in the early months of their term in hopes of retaining another five years of power and general legitimacy. This prospect has already led the NatWest team to change the Bank of England's forecast, anticipating faster rate increases and a slower bond sale program due to the prospect of increased government spending. They revised the 10-year Treasury yield target by the end of the year to 2.25%.
Overall the picture for sterling, which is already down about 11% this year, is more complex. While easing government fiscal constraints or lowering taxes could give the British economy a boost, it could also drive up inflation and put public finances under pressure. The new leadership will introduce other changes to market sensitive policy as well.
And for the UK stock market, domestic-focused companies are likely to get a boost if a new leader raises question marks over a planned increase in corporate tax next year. The British benchmark FTSE 250 is down 20% in 2022. Severe interest rate increases in the Bank of England and the British pound could have a negative impact on the FTSE 100, where about 75% of corporate sales take place overseas. Higher borrowing costs would also hurt consumers, and thus retail stocks such as Next Plc and Marks & Spencer Group Plc.
While a rate hike would widen profit margins for lenders such as Lloyds Banking Group Plc and NatWest, British bank stocks may remain under pressure as the country faces a recession. Investors in utilities and oil companies such as Centrica Plc and Shell Plc will keep a close eye on pressure to raise taxes on the sector to help with energy bills.
Regarding the broader trade and political risks, some analysts point to the possibility of improving the relationship with the European Union. Johnson has introduced legislation that would give Britain the ability to unilaterally adjust a post-Brexit settlement for Northern Ireland, threatening a trade war with the bloc. On the other hand, a new election could raise the existential risk of Scotland's secession from the United Kingdom.
GBP/USD Forecast
Despite the recent correction, the GBP/USD price is still in the range of a strong bearish trend, and stability below the psychological support 1.2000 opens the way for the bears to move further down. The most important support levels for the currency pair will be 1.1825 and 1.1700, respectively. The continuation of the British political vacuum and concern about the future of economic stagnation there will negatively affect any gains for the pound against the rest of the other major currencies, and therefore I expect to sell the GBP/USD from every rising level.
On the upside, there will not be an important first break of the current downtrend without the GBP/USD moving towards the resistance level of 1.2390 as seen on the daily chart below.
