Policies prop up pound

STERLING bulls breathed a sigh of relief yesterday after a broad sell-off in the dollar pushed cable to as high as $1.5588. This raised hopes that sterling would remain the best of a bad bunch and avoid weakness caused by looming austerity measures.

Although sterling has appeared the best of the G3 currencies, it has not managed to consolidate on gains against the euro and the dollar and has been stuck in a long-term holding pattern against both currencies. Over the past month or so, it has traded between $1.53 and $1.56 against the dollar and between €1.19 and €1.22 against the euro.

Even taking into account yesterday’s sharp sell-off in the greenback, the pound has not strengthened beyond the $1.5965 mark against the dollar over the past three months. Still the euro has been unable to make headway against sterling beyond €1.2353 despite all three economies suffering similar problems (see charts).

Analysts all seem to broadly agree: the pound will retain its strength, declining only slightly in the face of the coming austerity measures. The UK economy is certainly not in better shape than the Eurozone and the US, so why is sterling performing better than its peers?

The verdict seems to be that economic uncertainty in the US and the Eurozone is worse than in the UK at the moment. For example the Eurozone industrial production figures were disappointing. The prospect of further bad news from the Eurozone’s periphery and concerns about the sustainability of the US recovery are more uncertain than the UK’s own brand of troubles.

The dollar as a safe haven currency should be booming in this climate. But as Andrew Goodwin of the Ernst and Young Item Club says: “The dollar has stumbled lately because markets are genuinely concerned about the sustainability of the US recovery.” Confidence in recovery plans have really started to resonate with currency traders. Chris Hawkes says: “People are looking at a broader basket of factors” before they trade, needing to see three out of four positive macro indicators before deciding where to put their money.

So why are traders trusting in sterling right now? Surely the double dip speculation ought to send shudders down the trader’s spine? It turns out that simply having a blueprint for recovery appeases the market. Even pessimistic RBS analysts, who think that sterling has entered a new and potentially dangerous phase due to a slowing economy and soft domestic demand, say: “at least the UK has a plan.”