RATES OF INTEREST
David Jones of IG Index says: “The Greek crisis has weighed on sterling in recent weeks, knocking sterling-dollar back to where it was at the beginning of April.” He adds: “Concerns over sovereign debt drove investors to the relative safe haven of the US dollar and the still stuttering UK recovery – flat GDP in the past six months and unemployment claimants still relatively high – did nothing to counterbalance this.” Interest rate policy is undermining sterling and with the hawkish European Central Bank expected to raise rates from 1.25 to 1.5 per cent on Thursday, while the dovish Bank of England keeps them on hold at 0.5 per cent, expect sterling to remain weak.
Jones describes UK rate hikes as a “moveable feast.” He says: “Every month it seems the expectations for this get pushed further back. It is certainly difficult to see any immediate action, based on the Bank of England’s stance, until we get a real pick up in GDP.” He thinks rate hikes could be pushed back to next year. Simon Smith of FxPro says: “Markets appear not to be expecting the first tightening of rates from the Bank of England until June 2012, judging by what we are seeing in the overnight swaps market.”
BAD MONETARY MANAGEMENT
Currency valuations are driven in a large part by the crudities of central banking. Setting the “correct” interest rate is always and everywhere a fool’s errand. Nevertheless, it is possible to distinguish better and worse management. On this, both former and current US Treasury secretaries John Snow and Timothy F. Geithner have given the same warning: “Nobody can devalue themselves to prosperity.” Although some economists and commentators argue for a weaker pound and greater inflation to promote exports and lessen the UK’s debt burden, such a policy is likely to come at the very high price of regime uncertainty. Smith says people “may think the softer pound recently is a welcome development if it allows us to export more and rebalance the economy, as the Bank of England seems to want.” However, he notes in net terms we’ve not gained from the sharp depreciation in 2008 and the move will cause further pain for the Bank of England in higher import prices, testing its credibility even further. Michael Hewson of CMC Markets warns that with its large trade deficit, the UK will be importing even more inflation from the stronger euro.
The Bank of England is mandated to target 2 per cent inflation – yet CPI inflation, annualised in May, was 4.5 per cent. Threadneedle Street is losing the faith of those holding sterling. As former Fed chairman Paul Volcker, who knew how to manage monetary stability better than most, cautioned: “When people begin anticipating inflation, it doesn’t do you any good anymore.”