Category — British Pound Sterling

While the euro has been beating up on the US dollar recently, the British pound has not seen fit to join in.  Rather than rallying, the pound sterling has been hit by a variety of crises, including the weak global equities market and the US housing problems.  The resurgence of Foot and Mouth disease in the English countryside points to a further deterioration in the pound’s standing.

The weak stock market has proved especially damaging to the financial services-driven British economy.  And as credit continues to get more expensive, demand will dry up for whatever the City has to offer.  New reports have also surfaced from British banks that the subprime problems in the US are starting to have a negative effect across the pond as well.

Recent economic reports from Great Britain paint a mixed picture.  Retail Sales growth printed at 1.2%, the lowest level since November.  Currency traders drove the pound to a two-month low against the euro and to its second straight day of losses against the US dollar.  The concern in the FX market centered around worries that five consecutive interest rate hikes may be putting a brake on the British economy.  But GDP growth came in at 0.8% versus 0.7% expected, suggesting that monetary policy is still accommodative to further expansion.  But the market moving data out of London is the reemergence of Foot and Mouth disease, and it is this news that should strike fear into all currency traders long on the British pound.

If the disease is not contained, FMD is almost guaranteed to sink the British pound.  The first reported outbreak was on August 3, and a second case was found last night.  The area has already been quarantined, and a voluntary export ban has been established for England, Wales and Scotland.  The last FMD outbreak cost the British economy 10 billion pounds.  Meat prices rose 5% and inflation was estimated to be 0.1% higher. For the forex market, an analysis of the past is even worse.  In the summer of 2001, after the first reports of contamination in the livestock, GBPUSD fell from 1.4750 to 1.3680, a drop of over 1000 pips.  GBPCHF has already begun it breakdown.  All those with an exposure to the British currency should be wary of the current market and keep an eye out for future developments with FMD because the disease, and what happens with it, will be the major driver of action on the pound for the time being.

Yesterday’s report on the extremely sluggish U.S. housing market sent equities markets crashing, investors dumping corporate debt, and currency traders unwinding carry trades. New U.S. homes sales for June fell 6.6 percent. This number has jumped significantly from the 2.2 percent decrease in May. According to a Bloomberg article, this may be a no end to the real-estate slump. The housing issue has even breached the international level as a report today by the U.K.’s Nationwide Building Society showed home values to have risen only 0.1 percent in June, the slowest in 15 months.

The faltering confidence in the equities markets has also brought shifts in forex. Despite having been on a six-week run against the dollar, the pound took its biggest fall in the last five months. The pound dropped 1.0 percent in one day to $2.0305 at 1:04 p.m. in London from $2.0491 late yesterday. On July 24^th the pound had reached $2.0654, its highest level since May 1981. The pound and the euro also took major hits against the yen, indicating investors are losing confidence in their carry trades with the Japanese currency. Against the yen, the pound fell to 241.27 from yesterday’s close of 243.21. Steven Barrow, chief currency strategist at Bear Stearns Intl. Ltd. in London, states: “There’s a reasonable degree of panic going on with the whole mortgage and credit issue and that has encouraged risk aversion.”

Currency Outlook and Strategy:

The sharp fall in the pound has allowed the 14-day RSI for the GBP/USD to fall below 70. This indicates that a reversal will not come anytime soon. Kathy Lien, chief currency strategist at FXCM expects “room for more losses” in the pound. In addition, traders have taken steps to hedge against the risk of a rallying yen. The cost of options protecting against gains in the yen rose to a 3 year high. This movement of risk aversion indicates a revival in the carry trade may not happen anytime soon. Neil Jones, head of European hedge fund sales at Mizuho Financial Group Inc. in London, states: “Investors are looking for some short-term protection on their exposure to the yen strengthening.”

History has shown us an interesting pattern where the EUR/JPY pair has followed a very similar trend to that of the U.S. Dow Jones Industrial. As the Dow takes hits so does the EUR/JPY. See more on this pattern in an article by FXCM technical currency strategist Jamie Saettele. Overall, the leveraged-buyout financing era has taken a huge fall. There is much uncertainty as investors are shifting their portfolios toward less risky assets. Steve Pearson, chief currency strategist at HBOS Treasury Service PLC in London, reflects: “[The] three year period where financial market volatility has declined to low levels is over.” For now it is best to let the markets react and then change strategy.  

In the London market last night, EUR/USD underwent the correction that we had predicted yesterday.  The euro fell amid concerns that the forex market was overextended.  But there’s another currency that has performed even better against the US dollar: the British pound.  GBP/USD seems to reach new multi-decade highs every day.  The early momentum in this pair might have been about the interest rate differential between the two countries, but that is not the driving factor anymore.  If it was, then we would have seen a correction already because of the recent dovish data.  The Bank of England is still on track to raise interest rates to 6.00% this year, but the actual decision might not be for another couple of months.

The real reason for the success of the pound is the growing popularity of British assets.  British assets are denominated in pounds, and so when foreigners want to buy British assets, they are compelled to purchase pounds on the forex market.  Just recently, the investment fund of the Dubai royal family bought a stake in HSBC Bank, and the Chinese government bought shares in Barclay’s Plc.  DailyFX.com has some great analysis on the rise of the cable.  The demand for pounds is skyrocketing, and that is the main driver of growth in GBP/USD.

This very phenomenon is the reason that the US dollar has been so stable and strong through the years despite the twin deficits (budget and trade).  The demand for US stocks, US real estate and US Treasuries never waned, and the US dollar was the prime beneficiary.  But the global environment has changed.  Iran recently asked Japan to pay for its oil in yen instead of dollars.  Six Middle Eastern countries (Saudi Arabia, Kuwait, UAE, Qatar, Bahrain and Oman) are planning to drop their dollar pegs and establish a single currency for the region.  The growing protectionism in the United States (the scrapped deals for Dubai Ports World and CNOOC) certainly does not help matters.  American real estate is not as attractive in this market with prices sinking and the bottom in danger of falling out.  And US equities are not doing as well from an international perspective due to the depreciation of the US dollar.

In the face of the shifting paradigm, the pound did hit some stumbling blocks in the forex market today.  GBP/USD declined from its 26-year high last night, falling as low as 2.0539.  But the fall was not due to changes in the currency’s fundamentals.  Rather, the losses in the US equities markets triggered a bout of risk aversion, and the carry trade unwind led many currency traders to pare back on pound holdings.  But futures traders have positioned both the US stock market and the British pound for a rebound in later trading.  The sterling is looking like the currency du jour in the forex market, and traders would be smart to go along for the ride.

With oil prices still hovering around $70/bbl (and with a realistic possibility of $80 oil), world prices are not likely to go down anything soon. Both headline and core inflation are on their way up, and that makes inflation more of a concern for central bankers than growth. What that means for forex traders is continuing hawkishness for monetary policy makers and a steady rise in interest rates all around the world.

The Bank of England led the way today, raising interest rates to 5.75%. The accompanying statement was not as hawkish as some currency analysts were expecting, however. The central bank made the claim that inflation was starting to get under control, with CPI nearing the 2% target level. And new Chancellor of the Exchequer Alistair Darling came out and said that the higher interest rates should prove a burden on new debtors in England, especially those with fixed rate mortgages. Trade union groups as well as the business lobby have protested the rate hikes, citing a possible brake on growth.

But housing prices in Great Britain are still as high as they have even been in years. The financial services industry in London is booming, carrying the economy to its largest growth in three years. M3 money supply in England is growing at a dangerous pace, and the Monetary Policy Committee members recognize the inflationary risk there. Taking into account the rapid growth of credit and broad money, the MPC left open the possibility of future rate hikes this year. In fact, most forex market analysts expect at least one more move upwards in the interest rate, bringing it to 6.00%.

In confirmation of that fact, December short-sterling futures went up to 6.33% shortly after the interest rate decision. The British economy has been resilient thus far to interest rate hikes, and the Great Britain pound should benefit. GBP/USD is up 3% this year and GBP/JPY is up 6%. Fundamentals point to the pound continuing to be a great buy and currency traders should continue to provide bid support for the sterling. Look for the cable to test 2.0500 in the coming days and weeks.

The pound reached a new 26-year high against the dollar last night.  Still short of the important 2.0200 level, the gain was still impressive and primarily fueled by speculation on interest rates.  Among the major forex countries, there are a number of central banks having their meetings this week, but the Bank of England is the only one likely to raise interest rates this time.  With regard to GBP/USD, currency traders are being driven by the search for the highest yield.  With the Fed not likely to change rates any time soon, the differential is pushing the cable to new highs.

The strength of the pound in the forex market should not surprise most market observers; Terri Belkas of DailyFX.com predicted the new high in the cable last week.  The money supply is Great Britain is growing at an astronomical rate.  House prices continue to surge, and labor conditions are extremely tight.  The recent CPI report is at 2.5%, above the 2.0% level preferred by the BoE.  The latter might be the most important factor leading to Thursday’s rate hike, as Monetary Policy Committee member Kate Barker has said that the bank’s credibility is dependent on keeping inflation in check.

The pound was down yesterday against the Japanese yen, the Swiss franc and the euro, but its long-term strength seems secure.  Construction PMI printed this morning at 60.1, compared to the expected results of 57.7.  The economy seems like it can withstand future rate hikes with the threat of collapse.  With oil still above $70/bbl, worldwide inflation is not going to go away.  The BoE is the only bank likely raise interest rates this week.  And the futures market has even priced in another rate hike later in the year, which would bring the interest rate in Great Britain to 6.00%.  It is no wonder, then, that even with new terror threats in London and Glasgow, market observers are predicting even greater highs in the forex market for the pound against the dollar.

The most important news today (at least in terms of the foreign exchange market) is the release of the minutes of last month’s BoE Monetary Policy Committee meeting.  The release surprised most of the market with a more hawkish-than-expected stance.  The Committee did vote to keep interest rates steady in June, but the vote was much closer than many traders had predicted.  Most market analysts had expected a 7-2 vote against a rate hike last month, but the actual vote was 5-4.

In addition to that, Governor Mervyn King was one of the four dissenters calling for a rate hike.  The bank’s governor has only been overruled twice in the 10-year history of the Monetary Policy Committee.  Many traders today feel that with King now calling for a rate hike, the decision is almost a done deal.  Today’s release of the meeting’s minutes only confirms forex market speculation that began with hawkish comments earlier in the month by Governor King and others.

There are other important currency market considerations regarding interest rates besides the comments of the Committee members.  Money supply growth has reached its fastest annual pace in seven months.  Oil prices are still at $69/bbl.  Other inflation indicators are also robust, including the British housing market and the index of prices in shops.

It is difficult to predict the actual actions of central banks (that doesn’t stop currency strategists from trying).  But the various exchange markets have already felt the impact of the release of the Committee vote.  Futures market traders are betting on a rise in rates to 5.75% at the next meeting.  In the forex market, the future rate hike is being priced into the value of the pound right now.  For example, GBP/USD easily cleared 1.9900 after today’s minutes release, and it is likely not to encounter much resistance at 2.000.  The pound has also risen against the Japanese yen, climbing to its highest level since 1992.  Look for strong support for pound long bids in the coming day as the forex market prices in the likely BoE rate hike.

The defining action this weekend had traders basing their decisions almost entirely on yield differentials between countries.  In many cases, broad economic data was ignored in favor or inflation expectations and interest rates.  That’s why it is so important for foreign exchange traders to study the futures charts and determine which central banks the market thinks are likely to raise interest rates.  Example number one is the state of the US dollar.  Friday’s CPI report drove the market for the dollar.  Core prices rose only 0.1% in May, signaling that inflationary pressures were under control and in line with the growing economy.  As such traders in the forex market see no reason for interest rate hikes in the near future, and the dollar has suffered as a result.

The Japanese yen and the Swiss franc have also fared poorly in the currency market mainly due to interest rates.  The economic situation in Japan and Switzerland is completely different.  The Swiss economy is robust and growing at a rapid pace, while the Japanese economy, despite satisfactory GDP growth, still has to contend with weak consumer demand.  Yet both currencies are experiencing a similar freefall; low interest rates in both Japan and Switzerland make carry trading especially attractive.   The Bank of Japan not only did not raise rates in their meeting last week, but its comments suggested that it was unlikely to raise rates next time either unless consumer demand picked up.  The Japanese economy is simply not ready for interest rate hikes.   In Switzerland, despite much stronger economic data, the SNB chose to only raise rates by 25 basis points.  This did not do nearly enough to cut the rate differential between the franc and the other European currencies.

The situation is only exacerbated by the possibility of interest rate hikes by both the Bank of England and the European Central Bank.  The currency market is loading up on both the pound and the Euro in anticipation of in anticipation of those future rate hikes.  Hawkish comments about inflationary pressures by European Central Bank council members continue to bid up support for the Euro (EUR/USD at highest in two months) despite poor Industrial Production and Retail Sales data.  In England, BoE Governor Mervyn King is as hawkish as ever concerning rising inflation.  The likelihood of rate hikes is being priced into both currencies, leading to gains across the board, especially against the US dollar, Japanese yen and Swiss franc.

As mentioned last week, the GBP/JPY did in fact make the 100 pip gain. Not only that, but this week it will close where no week has closed since late 1992, passing the highest weekly close of 1998. This is greatly due to the surprise move of the Bank of Japan to keep interest rates at .25%. Three out of nine votes however were to raise rates, where the decisions in the last six months were all unanimous.

On a monthly chart the GBP/USD hits a rarely touched thirty year trend line.