There are good reasons to be concerned about the UK second-half economic outlook. Interest rate cuts are realistic, possibly as early as August. It is also possible the UK economy will suffer a vicious circle if debt concerns force government spending cuts and a downward spiral in house prices.

In the near term, interest-rate expectations remain important:

The narrowing of the UK’s interest rate premium, as the U.S. continues to increase rates while the Bank of England (BOE) cuts rates, will tend to weaken the pound. Also, the pound historically has been vulnerable to sharp moves when there is a definitive shift in market sentiment on the currency. Although the pound will certainly be very vulnerable if the yield premium on short-term UK investments disappears altogether, the U.S. economy exhibits many of the same vulnerabilities, particularly over the issues of debt, housing prices, and current account vulnerability. This similarity should lessen the threat of sharp UK currency losses, although over-shooting will be a risk.

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