THIS year, trade in sterling has been relatively subdued. With market attention focused on the euro, UK credit markets escaped scrutiny. This lack of limelight helped cable to maintain relative strength throughout the year. Some traders even argued that the pound deserved to be viewed as a safe-haven currency given the country’s independent monetary policy. Yet, in 2012, many of these assumptions may come under assault if the UK economy begins to weaken and the bond market vigilantes set their sights on UK sovereign debt – making it the next target of the shorts.
According to the McKinsey Global Institute, Britain’s total debt, which is composed of private, public and financial sector borrowing, is the highest in the world. Official figures have put UK government debt at around £900bn, which is equivalent to 60 per cent of GDP, however, if the financial sector interventions are included, Britain’s total debt figure reaches £2.24 trillion, or 147 per cent of GDP. That ratio puts Britain on a par with Greece and Spain, making its AAA rating highly suspect.
Up to now he UK has enjoyed relative calm in its credit markets, but if its sovereign debt comes under assault, it could face a nightmare scenario of high inflation and a massive contraction, as its debt service costs begin to rise. If UK debt faces a run by the shorts – much like the Club Med economies of Europe – the Bank of England will have no choice but to monetise the debt as the buyer of last resort. The irony of the situation is that while Germany remains fixated on the inflationary implications of an accommodative monetary policy, the true victim of high inflation could be the UK, since it already carries the highest baseline price levels in the G-20.
The UK economy spent most of 2011 under the radar, as focus in the currency market was squarely on the Eurozone. Throughout 2011, cable has been able to trade above the $1.5000 figure, but in 2012 that support level could crumble fast and the pair could see much greater volatility as its credit worthiness comes under question.