The pound has taken a beating in the past month or so as markets have read recent comments by Bank of England Governor Mervyn King that a weak currency may have advantages for the UK economy as a cue to dump sterling. On Wednesday, the pound’s trade-weighted index fell to a five-month low.
However, the pound rose slightly late last week after the Bank of England officials made no mention of currency movements when they emerged from their regular monthly policy meeting on Thursday.
With few fireworks resulting from the gathering, currency dealers and City analysts will look to the central bank’s November deliberations, at which its policy panel will have new economic forecasts on which to base its outlook.
Most analysts do not expect the Bank to extend its asset-purchase plans next month, even though the country may be emerging from recession.
“Right now we believe they will announce no further additions to the purchase programme in November, but much will depend on the economic news between now and then,” said George Buckley, chief UK economist at Deutsche Bank.
A sizeable minority of analysts still see a further expansion of the QE programme, which pumps money into the economy, because any recovery is likely to be fragile.
The UK currency has been pressured lower as its relative yield advantage over the euro and dollar have deteriorated further on the view the Bank of England will keep rates extremely low for some time.
The value of sterling has also been dented in recent weeks by a flow of dismal economic news.
UK industrial production fell in August, undercutting optimism about a swifter-than-expected economic recovery. That news helped drive share prices higher, partly on the expectation that policy makers would have to keep monetary conditions excessively easy for some time in order to ensure economic recovery. That domestic stance undercuts the attractiveness of the pound to foreign-exchange investors.
The grim economic news coincided with a short-term rate increase by the Australian central bank, the first Group of 20 nation to bump up the cost of borrowing since the financial crisis intensified more than a year ago. That move boosted the Aussie dollar to its strongest level against the pound since 1985.
Just as investors sorted good banks from bad banks earlier this year, foreign-exchange buyers are starting to single out strong currencies from weaker currencies. The pound appears to be joining the dollar in the weak camp. Both countries have near-zero interest-rate targets, an aggressive policy aimed at boosting the economy, and substantial deficits. The euro and Japanese yen have edged higher, and commodity-backed currencies, such as the Canadian and Australian dollars, seem most strongly positioned. Oil-rich Norway is also in the favoured camp, and its central bank is expected to follow Australia with a rate increase soon.
Not all countries are pleased with how the sorting is unfolding, and intervention in the currency markets has increased substantially in the past few weeks. While central banks did not confirm such moves, traders believe South Korea, Thailand and Singapore intervened early last week to slow their currencies’ rise against the dollar. Switzerland is believed to have made a similar move, and Japan has spoken loudly about taking its own steps to curb the yen’s gains.
While the dollar’s weakness is getting most of the attention, the pound may face an even bleaker future than the greenback. Investors speculate that UK central bank and Treasury officials may favour a weaker currency and could take additional measures to lift Britain’s ailing economy.
In the third quarter, sterling lost nearly 3% of its value against the dollar and gave up around 7% against the euro, reversing a positive second quarter in which it rebounded from multi-year lows against the dollar and euro. The pound was trading at about $1.59 on Friday, around the low end of its recent range of $1.59 to $1.65.
A weaker pound is adding to consternation among eurozone exporters. Already dealing with a weak dollar, the countries in the single-currency bloc now face the prospect that the pound will also fall hard against the euro. That would make eurozone exports to the UK, the bloc’s biggest trading partner, relatively more expensive. That scenario could hamstring Europe’s own ability to recover from the recession.
Investors again are focusing on the UK’s heavy dependence on the financial sector and how that part of the economy faces a long, torpid recovery, at best. Unlike the Reserve Bank of Australia, the Bank of England is not expected to raise short-term rates any time soon. Indeed, it is mulling even more aggressive moves to ease monetary conditions in a bid to boost the economy.
British elections could add to market uncertainty as political squabbling intensifies ahead of the vote. “Foreign investors are taking fright,” said Stuart Thomson, an economist at Ignis Asset Management in Glasgow.
But other observers remain upbeat about the pound’s future. “It is not surprising that there are stress fractures in the UK. But the pound is an international reserve currency, and London is still the financial centre of the world,” said Stephen Jen, managing director at BlueGold Capital Management in London, who says sterling is undervalued.
If the euro keeps rising against the pound and dollar, it could become a major problem for Europe’s economies in coming months. The region’s biggest economy, Germany, depends heavily on exports to fuel growth, while smaller economies like Spain and Ireland are hoping that exports could help revive growth.
And there are reasons to be especially concerned about the UK.
The pound’s slide picked up strength in early August, when the Bank of England expanded the size of its QE scheme, despite tentative signs of economic improvement. Meanwhile, King has said weaker sterling and lowering interest rates on reserves held at the central bank might be helpful for the UK economy.
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