Sterling rises as Sunak victory in PM race offsets economic gloom

By Amanda Cooper

LONDON (Reuters) -The pound rose on Tuesday, boosted by a degree of investor relief after Rishi Sunak became Britain’s next prime minister, although analysts said gains will likely be short-lived given a gloomy economic outlook.

The 42-year-old former finance minister is now Britain’s third prime minister in less than two months. Sunak said on Tuesday he would try to fix the mess left by his predecessor, restore trust in British politics and tackle a “profound economic crisis” but warned the country there would be difficult decisions.

Jeremy Hunt, who outgoing Prime Minister Liz Truss appointed as finance minister to replace Kwasi Kwarteng, is widely expected to serve as chancellor under Sunak. His first task is likely to be presenting details on what remains of the Truss government’s fiscal plan on Oct. 31.

Britain has seen its borrowing costs soar above those of far more heavily indebted nations, such as Italy or Greece, and the pound has hit record lows after Truss unveiled an economic programme that roiled financial markets and cost her job after just six weeks in office.

“One thing that will be unmasked, certainly in the next few days, is the whole line-up of poor fundamentals that existed before the mini-budget are still very much there. And what Liz Truss really did was accentuate a torrid time for UK assets,” Rabobank strategist Jane Foley said.

The government is already staring into a 44-billion pound ($49.80 billion) current-account deficit, while growth is slowing and inflation is in double digits.

“Yields have come down from the peaks and money-market rates have come back and there is a lot of hope that Rishi Sunak will be the market-friendly candidate that can deliver something with Jeremy Hunt next week which will be as market-friendly as it can given the circumstances. But we still have a looming current account deficit, which of course exposes sterling to the winds of international investors if they don’t like those UK fundamentals,” Foley said.

Sterling was last up 0.46% against the dollar at $1.1325 and up 0.6% against the euro at 86.97 pence.

The pound hit an all-time low of $1.0327 against the dollar in the wake of the mini-budget on Sept. 26. It has since recovered almost 9.5% in value, but is still down 16% so far this year against the dollar and around 4% lower against the euro.

Long-dated gilt yields, which were at the centre of the firestorm that scorched markets after the mini-budget, have almost returned to where they were before the release of the fiscal plan on Sept. 23, reflecting a greater degree of confidence among investors.

Volatility in the pound has collapsed since the mini-budget and is on track for a drop of 4 percentage points so far this month, although it is still well above its longer-term average.

Three-month volatility, a gauge of investor appetite, has dropped to around 12.85% from over 17% in late September. But that is still comfortably above the average 8.8% rate that has prevailed over the last five years, according to Refinitiv data.

“The fall in UK gilt yields does suggest one thing and that is we will probably see a budget delivered next week and all the indications are it will be delivered by Jeremy Hunt, the existing Chancellor of the Exchequer,” CMC Markets chief strategist Michael Hewson said.

With gilt yields falling, the pound is likely to struggle for gains, “largely on the basis that the economic outlook for the UK economy remains grim,” he said.

($1 = 0.8835 pounds)

(Reporting by Amanda Cooper; Editing by Christian Schmollinger and Maju Samuel)