Liz Truss resigns. The pound's problems have not been resolved

The news about the resignation of British Prime Minister Liz Truss was not met with much reaction from either the currency market or the debt market. The absence of a sell-off suggests the widespread assumption that the process of finding a new leader - which is expected to take no more than a week - will bring no more political uncertainty than what Britain already feels. Truss was the politician who held office for the shortest time.

A clear fiscal strategy

At this point, the market wants to see a credible fiscal path. However, there are several risk factors. Investors may start to doubt whether the fiscal plan can be reliably presented within a few days of the new prime minister's term of office. There is a chance that the plan will be postponed for a week or two. Let us remember that on November 3 there will be a meeting of the Bank of England.

Secondly, the question is whether all of the leadership candidates support Chancellor Jeremy Hunt's plans. The incentive for this is great, and no new leader will want to approach the markets in the same way as the outgoing prime minister. Markets, however, will be keeping a close eye on potential favorites for leadership - Rishi Sunaka, Penny Mordaunt and Boris Johnson. Failure to agree on the fiscal strategy will negatively affect the GBP and cause further increases in government bond yields.

Additionally, there is a chance that in the coming days and weeks the opposition Labor Party will submit a motion of no confidence in the government. The entire opposition calls for early elections to be called. These are scheduled to take place in 2024 or 2025.

What does the Bank of England say?

Bank of England is faced with a choice between an aggressive increase and the maintenance of ultra-high interest rates on mortgage and corporate loans (which will aggravate the depth of the recession in the first half of next year), and lowering market expectations, which threatens to weaken the pound and increase imported inflation. Recently, Ben Broadbent - the deputy chairman of the BoE - has made it clear that he believes market valuations are exaggerated, prompting the Bank of England to adopt a more conservative stance.

It is likely that government bonds will continue to be traded with a high political risk premium and the pound will be under pressure. Only in 10 days will politicians try to present a balanced budget. Until then, investors will be very uncertain about the GBP.

Source: Łukasz Zembik, OANDA TMS Brokers