Final answer:
In response to an outflow of Pound Sterling and a negative economic outlook, the UK central bank is likely to increase UK real interest rates to maintain currency value and attract investors.
Step-by-step explanation:
When investors have a negative view of a country's economy and start converting large sums of local currency to another currency for investment purposes, such as the case of the UK where Pound Sterling is being converted to US dollars, an outflow of the domestic currency occurs. This outflow increases the supply of the domestic currency on the foreign exchange market and can lead to a depreciation of the domestic currency. However, to attract investment and to compensate for the higher risk perceived by investors, the domestic country will often increase its interest rates to maintain its currency value. Therefore, in the situation described, where the Pound Sterling is being sold off, we would expect the UK real interest rate to rise as the central bank aims to ward off inflation and maintain the attractiveness of Pound Sterling assets.This is in contrast to a scenario where a currency is expected to appreciate. If the Pound Sterling were expected to appreciate, the demand for the currency would increase, investors would buy more Pound-denominated assets, and the UK could afford to offer lower yields on its government bonds because the anticipated capital gains from currency appreciation would compensate investors. But since the expectation here is negative, the opposite happens.