UK Sterling ..... from Poster Boy to Whipping Boy, and the biggest problems may yet lie ahead.

Wednesday 13th January 2016

UK Sterling ..... from Poster Boy to Whipping Boy, and the biggest problems may yet lie ahead.

ref :- General

How quickly things can change ..... it seems just the other day that the UK was being bracketed alongside the US as the two developed economies posting respectable growth numbers. As a result, it was generally assumed that UK rates would follow those in the US higher, and some even speculated that the Bank of England could even make the move before the Federal Reserve. The perceptions about the health of the two economies and the implications for higher rates boosted both currencies, an inevitable if not entirely welcome consequence of the two nations' position in the economic cycle. Now, for the UK, the landscape is looking rather different.

The Pound has fallen from 1.5200 against US$ to 1.4400 in little more than a month, a drop of over 5% and a 5 1/2 year low. Against the Euro, on Nov 30th it was trading around 1.4200 compared to today's price of 1.3300, a demise of more than 6% in 6 1/2 weeks. Plainly, something fairly fundamental has changed and as so often we can see one of those vicious circles at work :

Strong economic performance and subsequent concerns of a pick-up in inflation  LEADS TO  expectations of higher interest rates, which  LEAD TO  strong currency . The strong currency's malign effects on manufacturing and exports  LEAD TO  weaker economic performance which  LEADS TO  new expectations of no change in rates, which  LEADS TO weaker currency  .....  and since the market had got itself pretty long of sterling, the moves have been particularly sharp.

There have been signs that the UK's economy is beginning to struggle for a while, particularly on the manufacturing side. Being a much more open economy than the US for example, it is more vulnerable to world events and exchange rate fluctuations. These concerns can only have been heightened by yesterday's data, which showed November's Manufacturing Production -0.4% (exp. 0.1%) and Industrial Production -0.7% (exp. 0.0%), though this number may have been slightly slewed by unseasonably warm weather affecting the oil and gas sectors. All in all, not great reading and though the final GDP number for 2015 is still likely to be respectable, one's got to question which way the economy is headed, or at least at what pace.

One thing is becoming much clearer ..... we're not likely to see a rate hike in the UK in the near future. The latest data saw the last of the big boys who had been forecasting a hike in the first half of the year (JP Morgan) push back their call to November. Frankly, with absolutely no sign of inflation and the economy beginning to stutter it would not be a total surprise if it didn't occur until 2017. Anyway, tomorrow sees the monthly formal announcement of the BoE's latest decision on a change in rates (NO CHANCE !), together with the release of the last meeting's minutes and the usual statement. In truth, with things as they are this has become a bit of a bore but of course both will be studied for any change of bias amongst the MPC members. Governor Mark Carney (who also speaks tonight) has developed a record of warning against what is not expected and so, possibly quoting the high levels of household debt, he may refer to the possibility of higher rates in the future. If so, we doubt he'll find the audience very receptive just now.

All of which is interesting (up to a point !), and explains much of Sterling's recent weakness. But the issue of BREXIT is forming an ever-darker cloud over the UK currency as the possibility of a referendum as early as this summer becomes more likely. All kinds of heavyweights from the banking industry have been lining up lately to declare that to quit the union would be disastrous for the UK. "Leavers" might argue that "they would say that, wouldn't they ? The Financial Services industry will be one of worst hit ..." That's certainly true .... Frankfurt and Paris must be rubbing their hands at the prospect. But perhaps more surprisingly, the Sunday press carried news of a poll that suggested that of 100 top bosses, a majority felt that their business would not be adversely affected.

We must be missing something ..... there's an assumption about that if Brexit took place, the UK would be able to negotiate favourable trade deals with the EU even as it waved goodbye. At the very least, it is far from certain that the EU will feel obliged to accommodate its exiting former partner. And when the examples of Norway and Switzerland are put forward, it ignores the fact that in return for their trade pacts those two nations both pay into EU coffers and are subject to the kind of rules and controls that those advocating Brexit so despise.

Still, there are many intelligent brains that want "out", which is why it's a big issue and why, even at this early stage, it's weighing on sterling. For what it's worth, the bookmakers have it about 65 : 35 in favour of staying in. And as for the pollsters ? They make it a bit tighter but after their performance at last year's general election, the bookies seem the better guide.