AS ANY British tourist heading to the Eurozone or the US will be aware, our pounds don’t go half as far as they used to. Sterling has been the whipping boy of the currency markets for over a year now and there’s little sign, at least in terms of the big picture, that we Brits are going to be enjoying two dollars or €1.50 to the pound again any time soon.
But forex traders looking to profit from short-term movements in the markets are often focused on the small daily changes in currency pairs. It is worthy of note then that, in spite of poor public finances and the threat of a debt downgrade, sterling has been clawing back some lost ground against both the buck and the euro over the past week. The move from €1.11 to €1.13 won’t have had an impact on the average Briton and is still weak, but those 200 points in euro-sterling will have been lucrative for forex traders using leverage.
Sterling’s small rally was fuelled by nine-month highs in UK inflation, Kraft’s imminent takeover offer for Cadbury as traders anticipate further mergers and acquisitions, and a report from Goldman Sachs predicting that the UK will outperform major economies in 2010, says Ashraf Laidi at CMC Markets.
But has the opportunity been and gone to go long on sterling? According to Commerzbank FX analyst Ulrich Leuchtmann and his team, the UK’s economic fundamentals certainly don’t suggest a positive view of the pound. Rather, they see the British currency benefiting from a lack of alternatives. “On the one hand, many market participants do still not trust the dollar – due to the old prejudices which dominated 2009. On the other hand, they do not consider the euro an alternative due to the concerns surrounding Greece,” Leuchtmann says.
Although countries like France and Germany have pulled out of recession, the euro has come under pressure in recent weeks, as sovereign debt troubles in Greece have escalated. Similar problems in both Ireland and Portugal have also added to the single currency area’s woes.
FX traders, who might have taken a bet on France and Germany continuing to recover, may now be put off going long on the euro because of the currency’s structural problems. Britain is not performing significantly worse than either France or Germany at the moment and sterling is not affected by a complete fiscal meltdown in Greece, making it appear a better currency bet than the euro.
While gains in sterling may be minimal, forex traders using leveraged positions can capitalise on even small moves. These small gains might come about for three reasons, says Capital Economics’ senior markets economist John Higgins. Firstly, the potential for a pause in quantitative easing to be paused will reassure investors in the UK worried about inflation and should support sterling. Secondly, traders will start to factor in an improvement to the UK public finances.
Finally, the pound is no longer as mispriced as it once was. It is still overvalued relative to the dollar, based on purchasing power parity exchange rates, but it is significantly undervalued relative to the euro. This should give sterling room to move a little higher against the euro, providing that the UK’s domestic fundamentals don’t derail any upward momentum.
Optimistic FX traders could go long sterling-euro now, expecting a small improvement in UK fundamentals while the Eurozone is bogged down by Greece.