Pound Sterling up next in currency wars

Is sterling next up in the currency wars? The pound hit a new 7-month low against the dollar yesterday.

Lots of reasons for the drop to what is a 16-month low against a trade-weighted basket of currencies. Standard & Poor’s is rumored, again, to be weighing a downgrade for the United Kingdom and unemployment numbers due tomorrow are likely to show the country slipping deeper into a triple-dip recession.

But the biggest driver comes from a change at the top of the Bank of England. Incoming central bank head Mark Carney, currently governor of the Bank of Canada, has made it clear to Parliament and the financial markets that will be more willing to tolerate higher inflation than his predecessor Sir Mervyn King. From those statements,financial markets are gradually starting to price in an intentional weakening of the pound—call it Japan lite—in order to revive the U.K. economy. That—along with a recovery in the euro that has sapped the pound’s appeal as a safe haven–has sent the pound down and yields on government bonds—Gilts—higher. Future contracts on the pound were net long—that is they were betting on the appreciation of the pound—at the beginning of February, but have moved to a net short position by the middle of the month. (Shorts are looking for the pound to fall in price.)

Bond buyers are now looking for annual inflation to climb to more than 3.2% over the next decade as Carney changes the central bank’s inflation target to a band of 1% to 3%.

I think it will be harder to find a way to play a falling pound in the equity markets than it has been to play a falling yen in the Tokyo market. The Nikkei 225 Index is dominated by exporters and financials that would all benefit from a weaker yen. Major London indexes such as the FTSE have a more diverse membership with a big dose of international companies that wouldn’t necessarily benefit from a weaker pound. This may be an equity trade where we don’t have any alternative, if we want to play, but picking individual stocks. I’m looking and I’ll report on what I find.

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2 comments

• neilplus on 20 February 2013

  Jim, I agree with the overall thrust of your post, but have a couple of comments to add:

  1. The unemployment figures were actually slightly better this month, not worse, but the post-Christmas seasonal job losses and retailer failures won’t show up until next month and even the month after, so the jury’s still out on that one. I suspect that you’re more likely than not to be right in the end.

  2. The Bank of England has had an inflation target of 1% to 3% for some years now, so nothing has officially changed in that regard. The change is that Mark Carney has explicitly stated that he’s happy to stay near the top end of the band, instead of merely expecting it to happen with no (openly stated) preference either way.

  Personally, I suspect Mervyn King also privately preferred to leave inflation higher rather than lower, as a way of reducing the UK’s debt burden, but didn’t feel it appropriate to say so. At that point, I’m getting into tea-leaf reading, though.

  Returning to the main topic at hand, I’m pretty much on hold with respect to the UK stock market right now, waiting to see what happens next before I decide which way to jump. I’ll be interested to see what you come up with.
• rolfer1 on 20 February 2013

  Let’s all remember that the UK is a current, living example of the adverse economic, and soon social, effects of what “austerity” means!