GBP Selloff Ignites Concerns Over UK Fiscal Stress

The GBP/USD pair declined to 1.3529 on Wednesday, September 2, marking its second consecutive day of losses. The move is primarily driven by dollar strength, with the Dollar Index reaching its highest level in over two weeks near 99.75. Rising bets on Federal Reserve tightening are also adding demand for the US dollar.

The 10-year gilt yield surged to 5.294% on Wednesday, breaking an eighteen-year high set in June 2008. The 30-year gilt yield reached 5.904%, its highest since 1998. This significant increase in gilt yields should theoretically attract capital into sterling, but instead, it's having the opposite effect.

The reason for this anomaly lies in the fact that gilt yields are not carry, but rather a risk premium. Britain's high borrowing costs, with government borrowing running 69% above the prior year in July, and its reliance on imported energy, are driving these elevated gilt yields. As a result, currency markets have started pricing them accordingly.

The Bank of England is expected to tighten policy by 32 basis points by year-end, with a November hike seen as almost 70% likely. However, this tightening will come into a weakening economy, which could further suppress growth.