British Pound Losing its Risk Appeal as Conditions Deteriorate

Published September 26th, 2009 - 05:58 GMT

Some of the major currencies are showing strength against some pairs and weakness against others – a sign of underlying currents like risk appetite. However, the British pound was down across the board this past week, and in dramatic fashion. Prominent breakouts are starting to look the establishment of new trends as the struggling fundamental health of the United Kingdom begins to override the appeal the currency once held as a source for high yields. The next few weeks will be critical in establishing where the pound will head, and more importantly, where it fits in the market.




Fundamental Forecast for British Pound: Bearish

-    BoE Mervyn King says the weak pound “will be helpful” in supporting a feeble recovery
-    Upcoming spending cuts and speculation of a cut in the deposit rate means the BoE is running out of options
-    The Bank of England minutes show a unanimous vote to keep the bond purchasing program at 175 billion pounds

Some of the major currencies are showing strength against some pairs and weakness against others – a sign of underlying currents like risk appetite. However, the British pound was down across the board this past week, and in dramatic fashion. Prominent breakouts are starting to look the establishment of new trends as the struggling fundamental health of the United Kingdom begins to override the appeal the currency once held as a source for high yields. The next few weeks will be critical in establishing where the pound will head, and more importantly, where it fits in the market.

There is no doubt that risk trends will have an impact on what kind of direction and pace the British currency takes. However, it will likely start to be more of a one sided influence. Should risk tumble in the wake of the G-20 meeting as investors worry the capital markets can’t support their own weight without a government safety net, the pound will likely tumble. There is still a latent build up of risk appetite behind this currency that was fed by the belief that the recovery in the global economy and markets would be exceptionally beneficial for the United Kingdom which is generally considered to be the industrialized nation in the worst shape. As the outlook for a speedy recovery and fades, so too does the picture of London retaking its title of financial center of the world. Yet, what happens should sentiment actually improve? Even then, the pound will likely lag or even fade despite the positive turn.

Over the past weeks and months, it has become blatantly clear that Europe’s second largest economy is struggling to pull itself out of its deep recession; and the time frame for a return to growth is being continuously pushed back. Not only did the 2Q GDP numbers tell us that the slump was more intense than initially though; but we have also seen that policy officials are running out of options to support an orderly recovery. This past week, the minutes seemed to have a positive tilt in that there was a unanimous vote to keep the bond purchasing program at 175 billion pounds (whereas in the previous vote, the was minority dissention headed by Governor Mervyn King for a greater amount). Nonetheless, the central bank kept open the possibility of further expansion of this unorthodox policy. Another step that was speculated to under consideration was a cut to the deposit rate paid to banks that hold their capital with the BoE. This too was written off; but commentary by King and other MPC members continues to stoke speculation that either or both is still a considerable possibility. Without doubt, the central bank is running out of options to jump start the economy. The further the policy authority extends itself without a commensurate response from financial health or economic activity, the more dire the nation’s condition. Considering the government will have to follow through on a serious round of spending cuts in the near future (expected to be the biggest reduction in over three decades), time is certainly working against policy officials.

In the grand scheme of things, economic data is vital at this point; but a meaningful improvement in the outlook will come with time and a wide array of indicators. Nonetheless, there are a slew of indicators to account for next week – and perhaps even a few of them could help jump start optimism. Most prominent, but least likely to surprise, is the final reading of the 2Q GDP numbers. There is rarely a meaningful adjustment in this last recalculation of the data; but the new current account numbers, some spending adjustments or capital investment alterations would be notable. Among the other notable figures, mortgage approvals, net consumer credit and the money supply are important gauges for financial health. The BoE home equity withdrawal figure and PMI factory and construction data is growth focused. – JK


Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John at jkicklighter@dailyfx.com

You may also like

Subscribe

Sign up to our newsletter for exclusive updates and enhanced content