The UK continued to provide more positive signs about the economy’s ability to hold together in the face of difficult credit conditions, inflation, higher-for-longer interest rates and geopolitical challenges.
Today, we witnessed the Financial Stability Report (FSR) for the second quarter of this year, which confirmed the confidence of monetary policy makers in the strength of the economy and the banking system, while continuing to emphasize the risks surrounding the financial markets that may trigger selling waves.
The report emphasized the resilience enjoyed by household borrowers, even though they are still under pressure from rising prices and high interest rates, the full impact of which may not be felt until another two years later.
It is also worth noting that the report stated that banks are still able to provide more support to household and businesses borrowers even as financial and economic conditions deteriorate unexpectedly. While economic growth expectations rose only slightly from what they were in the first quarter.
On the other hand, although the report praised the ability of stock markets to adapt to the high interest rate environment, it warned of the possibility of a “sharp correction” as this adjustment to that environment has not yet become complete.
While he warned that this violent correction in the stock market will find its way into the real economy by weakening the ability of companies to borrow with declines in the value of collateral – which may take the form of shares – in addition to that the correction may harm investors with financial leverage, and this may deepen market losses and reduces risk appetite.
This warning of a sharp correction coincides with markets pricing in the direction of more growth and economic recovery and reducing the impact of external geopolitical factors, according to the report as well. Therefore, the deterioration of surrounding external conditions may in turn cause a sharp correction in markets with relatively high valuations.
Geopolitical risks come from the possibility of the conflict in Ukraine escalating beyond its current borders, after the US allowed the targeting of the Russian interior, and this is what prompted Russia to seek to deepen its military cooperation in an unprecedented way with its partners. On the other hand, escalation may come from the conflict in the Middle East on more than one front, with the stagnation of the negotiating track.
However, the British pound is recovering today and rising by more than 0.2% against the US dollar and reaching the level of 1.26505, after reaching its lowest level in forty days yesterday.
The pound’s gains come in conjunction with the recovery in UK gilt yield, which reached the highest levels since the middle of this month, in contrast to the relative stability of US Treasury yield. The 10-year gilt yield was 4.155% and the US Treasury yield was 4.324%.
While the yield gap between 10-year Treasury and their equivalent from the UK is declining today and amounts to 0.167%. While this gap displays an upward trajectory in favor of US Treasuries, which, if it actually continues, may cause the pound to remain at relatively low levels against the dollar in the short term.
