Sterling looks weak but not as frail as the euro and dollar

 
Philip Salter
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STERLING has had a tough year. An underwhelming recovery and loose monetary policy from the Monetary Policy Committee (MPC) have had their impact, neither of which looks to be imminently reversed. But bad as things are, the monetary authorities in the US appear to be wedded to keeping interest rates lower for longer than the UK, while an implosion in the Eurozone would bolster the pound.

According to Angus Campbell of London Capital, sterling “has suffered this year as the Bank of England (BoE) continues to keep interest rates at all time lows. With little or no yield from holding sterling cash, investors have on the whole shunned the currency throughout the year.” However, other currencies have fared worse. Ian O’Sullivan of Spread Co says: “One of the clearest things about sterling this year so far has been its strength versus the weakness of the US dollar and the Japanese yen, but relative weakness versus the euro and the Swissie.” However, with debt crises blighting the Eurozone’s periphery, a flight from euro to sterling could be on the cards.

Recently, sterling has suffered. The services PMI report, which showed a fall from 57.1 to 54.3 for March, gave it a big hit against the dollar, as expectations were set for a smaller decrease. Contributing to this fall were the reduced manufacturing PMI, which fell from 56.7 to 54.6 and construction PMI, which fell from 56.4 to 53.3. On Monday, reports on the state of the UK housing market were disappointing. The Halifax House Price Index showed prices dropping 3.7 per cent in the three months to April, while the Royal Institute of Chartered Surveyors (Rics) showed the majority of surveyors and estate agents see house prices as falling – not as many as some feared, but certainly not good news.

WHAT TO WATCH

There are a number of upcoming announcements that could move sterling. Later today, the BoE Quarterly Inflation Report will be released, setting out inflation projections. Sterling could climb if the BoE projects inflation to climb this year. Although in the long run inflation diminishes a currency’s value, in the short-term sterling would strengthen in anticipation that the MPC will raise interest rates. Mervyn King’s comments will be key for those looking for a change of sentiment, as he delivers his press conference later today. On Thursday, the UK’s industrial and manufacturing production figures will be released. Expectations are for a rise, but given the inaccuracy of these predictions in the past traders shouldn’t count their chickens.

Campbell says “growth prospects continue to influence the voting behaviour of the MPC, who remain reluctant to raise rates in case it knocks us back into a recession.” Adding that “only three months ago their expectations were for the first quarter GDP to come in at 1 per cent, but it’s only managed half that. As a result, we can expect downward revisions to their growth forecasts and this could impact sterling negatively.” Michael Hewson of CMC Markets thinks “the pound has remained remarkably resilient given that the CBI announced it was lowering its growth forecasts.” Adding to complications, volatility in oil and other commodities makes it very difficult to predict inflation, says O’Sullivan. Hewson points out that following the recent commodities correction oil came off its £77 high to fall to £65, but has recovered to £70.

As weak as the prospects for sterling are, those for the euro and dollar are worse. David Jones of IG points out that sterling has climbed over five per cent against the dollar since the start of 2011. He suggests only with a move below $1.62 will this position be threatened. Hewson agrees, adding that markets are currently expecting the Fed to raise interest rates even later than the Bank of England. Also, with the euro having hit the rocks, if it sinks, many euro-holders will likely jump ship into sterling.

A protracted recovery in the supply and demand side of the UK’s economy, declining house prices, sustained unchecked inflation and low growth expectations are all working against sterling. Yet despite this, the dollar and euro have the potential for greater downside movements, so as bad as things are, they could be a whole lot worse.