Will the UK make the same mistake as in 2022?

The British pound suddenly comes under considerable pressure in early 2025, as a result of unrest on the bond market. The big question is whether the British government has learned from the painful lesson of 2022 and will work hard to restore confidence.

The British pound emerged as an absolute trendsetter on the currency markets in the last months of last year. Since the second week of August, the rate has shot up from €1,16 to almost €1,22. That was the highest level in over eight years. The rise of the pound is largely due to the high policy rate. The current rate of 4,75% is the highest of the G10 countries. In addition, the British economy is significantly less dependent on the export sector than, for example, that of Japan, China or the European Union. The pound is therefore much less sensitive to the threatening tariff rhetoric of incoming president Donald Trump than, for example, the yen, renminbi or euro.

Brutally disturbed
The beautiful picture was brutally disrupted a week ago, however, when the interest rate on British government bonds suddenly started to rise. The interest rate on longer-term bonds with a term of thirty years is now 5,3%. That is the highest level since 1998. A rising bond yield is often a signal that financial markets have somewhat less confidence in a country's ability to meet the interest and repayment obligations on its government debt. In other words: the United Kingdom must take action to restore the confidence of bond investors. The developments bring back memories of the major financial turmoil of autumn 2022.

To take the lead
At the time, newly appointed Prime Minister Liz Truss had drawn up a budget with substantial tax cuts for the wealthier British. Since there were hardly any savings to offset this, the budget deficit threatened to increase considerably. Investors then sold British government bonds en masse. This made it impossible for Truss to finance her plans. She had to back down in an embarrassing manner and resigned a few weeks later. The current government led by Prime Minister Keir Starmer must of course not make the same mistake. Chancellor of the Exchequer Rachel Reeves casually remarked that she was sticking to the budget policy that had been set, and then she blithely travelled to China for a few days.

Ostrich politics
If the unrest flares up further, Reeves cannot afford to bury her head in the sand again. For the time being, that is not the most likely scenario. There has been no major outflow of foreign investors from British government bonds. Moreover, the risk premium on the CDS market – where parties can insure themselves against default – has barely increased. It seems that bond traders are mainly taking a position on a British interest rate that will remain high for longer than initially expected. That is accompanied by some turbulence, which is taking the wind out of the sails of the pound on currency markets. Unless Reeves lets it slip through his fingers completely, the false start of the British currency is not a harbinger of a free fall in 2025.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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