I WAS reading the news the other day and a headline caught my eye: “The Pound Plummets”. I couldn’t help but feel that it is too early to use “plummets” in this context.
Since the beginning of this year, the pound is down around seven per cent against the dollar, but we have been quick to forget how aggressively the dollar was sold last year.
Steven Gallo, head of market analysis at Schneider Foreign Exchange says it is not too early to start thinking about the unwanted effects that the pound’s volatility could have. If a currency creates more shocks for the economy versus helping it rebalance, Gallo points out that it means Britain probably would be better off with a fixed currency instead of a floating one.
This notion is interesting. Britain has the highest level of inflation in the industrialised world, and a large part of this is due to the drop in sterling. According to Gallo, if the Bank of England is up against weak growth and high inflation, the market may sell sterling on the idea that the Bank of England’s flexibility is removed (i.e. the central bank won’t support the gilt market nor hike rates). Gallo says he wouldn’t be surprised if the issue of whether we should adopt the euro will come up again.
According to Asraf Laidi, chief strategist at CMC Markets, as long as we are moving towards the possibility of a hung parliament, traders will take this as an excuse to sell the pound. The reality of the markets, he says, is different though, with focus still being on whether we will see a double dip scenario (fourth quarter GDP looked slightly better but only as third quarter growth was revised down). Laidi also says the Bank of England is going to be forced to step in and stabilise the fiscal situation as a debt-to-GDP ratio of 75-80 per cent of GDP in the UK is possible.
Currently, when comparing the main central banks in the west, the Bank of England is the closest to injecting fresh liquidity into the system. The US Fed, the Australians and the Canadians are either withdrawing liquidity or thinking about it, and while the European Central Bank is not injecting any more liquidity, its European debt woes means it is in no rush to exit either.
Louisa Bojesen is a presenter on Squawk Box Europe each weekday morning on CNBC, http://europe.cnbc.com