The pound continued its downward trajectory on Friday, before slightly recovering, after slumping to two-year lows as the Bank of England (BoE) hiked borrowing costs to a 13-year high and warned of a possible recession.
The currency was also knocked as the UK faces an economic downturn, with Threadneedle Street no longer set to raise interest rates as fast as previously forecast.
The central bank said the British economy was set to contract sharply in the last quarter of the year when the energy price cap is lifted again, following a sharp downgrade by its analysts.
Output has been predicted to collapse by close to 1% in the final three months of 2022.
Read more: Is the UK heading into a recession?
Bank analysts had also previously forecast for growth of 1.25% in 2023, but are now warning that GDP is expected to shrink by 0.25% next year. This would mark the second annual contraction in just four years.
On Thursday, the pound suffered its worst day since March 2020, when the pandemic caused markets to crash, falling nearly two and half cents on the back of the news.
BoE governor Andrew Bailey said the forecasts did not meet the technical definition of recession but that of a very sharp slowdown.
“Sterling has reacted to the bank’s lack of clarity, and indeed the threat of a UK recession, in a negative fashion and is currently back trading below the 1.24 level versus the US dollar,” Matthew Ryan, senior market analyst at Ebury, said.
Meanwhile, Neil Wilson of Markets.com said: “There was nothing in the economic outlook nor in the BoE response to sound bullish on sterling.
“We can only hope that the dollar is overbought and can drop, but sterling looks highly exposed now to CB divergence. The euro may differ as long as it hikes at least twice over the summer. Again the key is when risk-off ends.”
In bond markets, gilt yields also fell sharply as investors reassessed the position of the economy.
“We are witnessing a clear depreciation of sterling during 2022 which is placing it as the third-worst performing major currency,” Jesús Cabra Guisasola, a senior associate for global capital markets at Validus Risk Management, said in a flash research note.