Deutsche Bank warns of increased threat of “sterling crisis” due to Truss becoming PM

The day before, it became known that Liz Truss won the race for the Prime Minister post in Great Britain. She also succeeds Boris Johnson as the leader of the Conservative party after a long stand-off with Rishi Sunak, who previously served as the Minister of Finance. According to voting results, Truss won the votes of more than 80 thousand Party members, while Sunak received a little more than 60 thousand votes.

Following news of the voting results, Deutsche Bank experts expressed their concerns about the further economic situation. Deutsche Bank published a note on Monday, in which the importance of the upcoming British political statements for the global economy was highlighted, if the country’s government is looking forward to avoiding extreme events, including a balance of payment crisis. 

According to the statement of the Germany's largest financial conglomerate, as record levels of account deficit are already reached, vast capital inflows combined with growing confidence of investors and decreasing inflation are now necessary for the pound sterling. But actually the opposite is the case, as noted by Deutsche Bank.

The financial company’s specialists said that the current rates of inflation in Great Britain are the highest in the G10, and the possibilities are starting to look bleak. Deutsche Bank warns about the further possible growth of inflation expectations, and, in case of the most extreme scenario, the probability of fiscal dominance, which might become the result of a massive and unfunded fiscal expansion backed by revisions of the Bank of England’s mandate. 

The Bank of England and its head Andrew Bailey have come to the watchful attention of Truss during her election campaign with the assumption that the 40-year record levels of inflation were allowed by the Bank. According to some reports, Truss is considering possible changes being made to the Bank’s mandate.

Among her other statements, it’s also worth noting her suggest canceling the Northern Ireland protocol, which is the main element of the post-Brexit agreement between the country and the EU. Such an action is likely to trigger a corresponding reaction from the block.

A lack of certainty in the area of trade policy might also affect the macroeconomic situation, which is getting more and more complicated, and result in failing investors’ confidence. If the confidence continues shrinking, there’s a high possibility of a self-fulfilling balance of payments crisis happening. This might occur if the foreign actors stop funding the country’s external deficit.

As it is estimated by Deutsche Bank, it’s necessary for the trade-weighted sterling (which is measured in relation to most important currencies in international trade) to decrease by 15%, so the deficit goes back to its 10-year average levels.

Such a crisis of funding a balance of payments might seem extraordinary, although similar events have already happened before – the same situation when a massive spending was combined with an extreme energy shock and a decline of the sterling took place in the 1970s, when the government had to turn to INF loan.