Synopsis:

Despite recent GBP weakness and a gilt market selloff evoking memories of the 2022 mini-budget turmoil, Credit Agricole doubts a repeat of that crisis is likely. Resilient economic fundamentals and moderate sovereign risk mitigate the risk of another major downturn.

Key Points:

1. GBP Under Pressure:

   • GBP is the worst-performing G10 currency in early 2025 due to disappointing UK economic data and a gilt market selloff.
   • Investor concerns about the Labour government's fiscal deficit target and elevated borrowing costs are intensifying pressure on gilts and GBP.

2. Drivers of the Gilt Selloff:

   • Global inflation fears have weighed on bond markets globally.
   • Domestic concerns include weaker economic growth and potential fiscal overshooting, possibly requiring additional austerity measures by March.

3. Why a Repeat of 2022 is Unlikely:

   • The widening of UK sovereign CDS spreads has been modest, signaling lower sovereign risk compared to 2022.
   • Historically low unemployment rates and gradual BoE easing could support economic resilience, reducing the likelihood of a full-blown crisis.

4. Stagflation Risks:

   • Elevated inflation and a weaker growth outlook could deter GBP investors, maintaining pressure on the currency in the near term.

5. Near-Term Focus:

   • Markets will closely watch the BoE’s inflation expectations data and a speech by MPC member Sarah Breeden for clues on policy outlook and economic resilience.

Conclusion:

While the GBP remains under pressure, Credit Agricole believes a repeat of the 2022 gilt market turmoil is unlikely. Moderate sovereign risk and a resilient labor market could provide a buffer, but the stagflationary backdrop remains a challenge for GBP recovery in the near term.