Looming interest-rate decisions could give options to spread betters, writes Katie Hope
If you were planning a quick shopping trip to New York to take advantage of the weakening dollar, you may have missed your moment. The pound’s strength against the dollar is finally on the turn.
In the past month sterling has seen its biggest one month fall against the dollar, since Black Wednesday, when the British pound was forced to leave the Exchange Rate Mechanism almost 16 years ago.
Growing recession fears and the prospect of interest rate cuts to shore up the flagging economy are all taking their toll on our national currency. Meanwhile at the Federal Reserve, where chief Ben Bernanke’s trigger happy approach to interest rate cuts has up until now seen the dollar plunge dramatically, they are making hawkish noises. All Fed members think the next interest rate move should be up, and that in turn is helping the dollar.
In the UK the MPC, which has so far turned its nose up at the spontaneous methods of its US counterpart, looks likely to be forced into finally making some cuts of its own.
In its recent quarterly inflation report Bank of England governor Mervyn King conceded that inflation should fall back to the its 2 per cent target in two years causing an instant leap in interest rate cut expectations and a sharp drop in the pound against the dollar.
Markets are now pricing in a 75 basis point cut in interest rates over the next 12 months, a sharp turnaround from just mid-June when they were pricing in a 75 basis point cut.
With the Bank of England likely to start cutting rates before the end of the year and the UK growth outlook deteriorating relative to that in the US, a further depreciation in sterling against the dollar is likely.
If you’ve had the foresight to be long on the greenback then it’ll be champagne all round, but it’s not game over yet.
The Bank of England rate decision on Thursday still has the potential to shake up the current situation.
The majority view is that the MPC will leave rates on hold, but bad data between now and then could lead sterling to drop on expectations of a cut sooner than this.
Tim Hughes, head of sales trading at IG Index, says, “A cut this week is not beyond the realms of possibility. Lower interest rates will make the pound even less attractive. If you think there could be a cut then a short position on sterling is the trade to place.”
Or you could take an even more contrarian view and bet on the pound strengthening against the dollar.
“Concerns over the health of the financial system and repeated seizures in credit markets will cause the first leg of the dollar’s rebound to encounter hurdles along the way,” says Stephen Gallo, head of market analysis at Schneider FX.
The long term trend however seems to be for further weakness against the dollar. “Over the next 12-24 months, we expect the MPC to cut rates to about 4 per cent with USD/GBP falling to about 1.50 and EUR/GBP down to about 0.83,” says Michael Saunders, economist at Citigroup.
Maybe time to cancel that flight to New York and go shopping on the UK high street instead. After all, with bargains galore to tempt you into spending there could be better value here than in the US. And you’ll be helping the UK economy while you’re at it.