BAD noises have been rumbling around sterling for months now, but they got considerably uglier in the past days. The world’s biggest bond fund, Pacific Investment Management Co (the cutely-acronymed Pimco), announced earlier this week that it is to cut its exposure to UK government bonds. This raises the spectre of other large investors losing confidence in the UK’s economy. This is not good news for sterling.
So what else could happen, and how low could the pound go? The Bank of England, which has propped up the UK gilt market since March 2009 when it started its programme of quantitative easing, may choose to extend purchases by another £25bn later this year. But the BoE can’t afford to keep gobbling up gilts and when it does finally announce the end of quantitative easing then there are sure to be more investors who will follow Pimco’s example and head for the exits.
The whispers that the UK’s fiscal debt problems could lead to a sovereign debt downgrade by the credit ratings agencies are also adding to the din. Scott Mather, Pimco’s head of global portfolio management, said during an interview with Dow Jones Newswires yesterday that there was an 80 per cent chance of a credit rating downgrade for the UK if it doesn’t implement a credible debt reduction plan. This is big news coming from one of the largest bond investors in the world. Mather also said that gilt yields could rise by 100 basis points when the Bank ends their quantitative easing program.
The cost of insuring British sovereign debt against default has risen, making it an unattractive asset. All of this makes it more and more likely that investors will give the UK a wide berth in 2010.
You don’t have to be George Soros to predict that sterling will drop like a stone in 2010. Even a general economic recovery by the country’s biggest companies would not buoy the currency, as they derive a lot of their income from overseas. Sterling is a purer play on the UK economy. It looks utterly dire, and so the pound’s prospects are equally grim.
Some well-known names in the City, such as David Buick from BGC Partners, think that sterling could reach parity with the euro, and fall to $1.50 against the dollar.
Optimists have suggested that a weak pound can ignite our economy and boost exports, but the fact is that a large proportion of our exports are in services, a sector that is less reactive to currency fluctuations than manufacturing. More likely is that weak sterling causes a spiral effect, as imports become more expensive and push up inflation, making the currency even less attractive. The road ahead looks bumpy for sterling. Selling the currency, and fast, is the only game in town.