The situation surrounding the British pound has taken a turn for the worse as key financial institutions weigh their options to short the currency amidst growing concerns over the UK’s economic healthInvestors are increasingly apprehensive about the future, with significant shifts in sentiment following the latest decisions from the Bank of England (BoE).

The recent policy adjustments from the BoE appear to have only amplified fears of sluggish economic growth, with indications that investors are bracing themselves for further depreciation of the poundSince the beginning of this year, a multitude of asset management companies, including the likes of Baillie Gifford, have drastically diminished their bullish positions on the currencyNotably, Hartford Funds and Russell Investments have similarly scaled back their exposure, while RBC BlueBay Asset Management suggests that existing short positions on the pound may still have room to grow, especially with market speculation that further rate cuts from the BoE are on the horizon.

Last Thursday, following a quarter-point rate cut by the BoE, the pound plummeted by 1.2%, marking its position as the worst-performing currency among the G10 in 2023, although it did see a slight recovery shortly after

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This comes despite the cut being largely anticipated by the marketHowever, the bank's forecast adjustments, which saw growth expectations halved, were not well received, especially as two committee members, one of whom was previously a hawkish voice, voted for a more aggressive 50 basis point cut.

Shaniel Ramjee, a portfolio manager at Baillie Gifford, articulated the deep-seated challenges facing the pound, suggesting that under the current fiscal constraints and economic growth parameters, sustained demand for the currency seems unlikelyHe noted, “We still believe the UK economy faces risks and that the BoE may need to adopt further rate cuts,” emphasizing that he has reduced his firm’s pound exposure to the bare minimum required for their portfolio.

This stark market reaction underscores the urgency for Chancellor of the Exchequer, Rachel Reeves, to fulfill her commitment to accelerate economic growth

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The rationale that helped to buoy the pound over the last two years—namely, the assumption of markedly higher interest rates in the UK compared to other G10 nations—has now faltered.

The increasing likelihood of aggressive rate cuts by the BoE has eroded the pound’s long-standing appeal as a high-yielding currency, which, compounded by the lack of anticipated inflationary pressures, has diminished its growth potentialPresently, market pricing elucidates clear expectations about the direction of UK monetary policy, revealing that many market participants believe the BoE will enact two more cuts this year, with the probability of a third cut rising sharply.

Tracing back to January, the atmosphere was markedly different, with traders forecasting perhaps only two rate cuts by 2025. However, since that time, there has been a marked upswing in bets for a more dovish stance from the BoE

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UBS has forecasted even more bearish prospects, predicting that the Bank may enact up to five rate cuts by the year's end, following the developments this past Thursday.

These rapidly shifting expectations reflect the intricate and evolving economic landscape, leaving investors teetering between caution and the delicate promise of future gains in the UK’s financial marketsAs monetary easing progresses, projections suggest further depreciation of the pound, with ING predicting the GBP/USD exchange rate might fall to 1.19 later this year—a low unseen since March 2023. Furthermore, BBVA anticipates a decline in the GBP/EUR rate, with forecasts suggesting the euro may rise to 0.85 against the pound.

Meanwhile, Nomura’s currency strategist, Dominic Bunning, indicated in a report that the latest voting outcomes “could continue to exert pressure on UK short-term bond yields and intensify downward pressure on the pound.”

Even comments from BoE Governor Andrew Bailey, aiming to downplay the dovish voting shift, appeared ineffectual at stabilizing the pound, asserting that he does not view the changes as inherently dovish

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Some investors interpret his stance as reflective of a looming concern over stagnation, given that inflation remains stubbornly high even as growth slows.

Martin Harvey, a partner at Hartford Funds, commented, “In the short term, the outlook for UK economic growth looks softening, yet inflation continues to remain elevatedThis represents a poor combination for a currency and has certainly dampened our previously optimistic view on the pound.”

Since last year, Hartford Funds has been deliberately reducing its bullish positions on the poundSimultaneously, RBC BlueBay Asset Management maintains that should inflation lead to a repeat of surging UK bond yields observed earlier this year, their overarching short positions on the pound may still have further room for strengthening.

Kit Juckes, Chief Forex Strategist at Société Générale, encapsulated the sentiment succinctly: “If the BoE’s rate cuts are equal to or exceed what people expect, then why would I want to take long positions on the pound at the current level of interest rates?”