Update – 5 Reasons Why the British Pound is Being Pounded – Access my latest article Feb 28, 2010
How Did the British Pound Trade in 2008?
The British pound was one of the worst performing currencies in 2008. It fell to a 6 year low against the US dollar and record low against the Euro in addition to selling off against every other G10 currency. The overwhelming weakness in the currency is a direct reflection of the impact that the credit crisis had on the UK economy. In the month of December, many currencies recovered against the US dollar, but unfortunately the British pound was not one of them. Although the pound could continue to weaken in the first quarter, the government’s aggressive fiscal and monetary stimulus should help the country recover towards the end of 2009.
Official Recession in 2009
Without two consecutive quarters of negative GDP growth, the UK economy is not technically in a recession but that should change in the first quarter of 2009, when the 2008 Q4 GDP numbers are released. Growth has been slowing materially and the weakness is reflected in the British pound. GDP growth fell by 0.6 percent in the third quarter, the largest decline in 18 years. The housing market and the financial sector have been the engine of growth in UK for the past few years and both blew up in 2008. Unfortunately the worst is probably not over for the 2 key components of the UK economy, particularly following the Bernie Madoff’s Ponzi scheme. In addition to losses suffered from the subprime mortgage crisis, many large hedge funds and European banks invested with Madoff’s. In 2009, they will be forced to write down those losses and deal with what could be pretty severe consequences for the financial sector as a whole. With the financial and housing market sectors expected to remain weak in the first half of 2009 and layoffs predicted to rise, GDP growth could fall as much as 2 percent next year. Although we believe that the country could be one of the first to recovery from the global economic downturn, this will not before more pain is felt in the UK economy. The severity of the UK recession will be largely dependent upon how quickly the credit markets are restored in 2009.
Inflation to Fall Back to 2%
As you know, I have been very bullish EUR/GBP this week. On Monday, I showed you this chart of EUR/GBP and told you that is headed for 90 cents from 87 cents and today it has pretty much reached that level. The high in EUR/GBP was 0.89978, 2.2 pips from my 0.90 target.
One of the questions asked in the comment section of my blog earlier this morning was “Is it time to sell near .90 or will it continue to slowly go up?”
As you can see in the chart below, the retracement off of the 90 cent high was pretty brutal. Although I think that EUR/GBP could hit parity, we may be due for an even larger correctionthat could take the currency pair back to 0.8750.
US retail sales and producer prices were basically in line with expectations but that does not undermine the fact that the data was very weak and confirms that the Federal Reserve will be cutting interest rates by 75bp next week. USD/JPY hit a 13 year low last night after news that the automaker bailout plan is not going happen before the new year. Everyone had hoped that the automaker saga would come to an end, but lawmakers are not letting that happen. On Wednesday, I said that USD/JPY could hit to a new 13 year. At that time, the currency pair was trading at 92.50-93.00. The possibility of the US taking interest rates below Japanese levels should keep the US dollar soft going into the Fed interest rate decision on Tuesday.
Consumer spending fell for the fifth month in a row while producer prices dropped for the second straight month. The two biggest inputs into GDP are retail sales and trade. Consumers cut back spending more aggressively in October and November which suggests that GDP growth could take a big dive in the fourth quarter, especially with the widening of the trade deficit.
GDP Could Contract by 4 to 6% in Q4
GDP could decline as much as 4 to 6 percent in Q4, which would be the largest contraction in growth since the 1980s. In the first quarter of 1982, GDP fell -6.4 percent. A 4 to 6 percent drop in GDP would not be out of the ordinary given the current conditions in the US economy. In the fourth quarter of 1990, GDP contracted by 3 percent and in the first quarter of 1991, it contracted by 2 percent. The currrent recession is worse than the one the US economy experienced in the 1990s, so a contraction in growth exceeding 3 percent would actually be expected.
The biggest drop in consumer spending came from gasoline station receipts. Prices at the pump have fallen more than 50 percent since the summer and gas stations are suffering as a result. The only silver lining in the retail sales report is the fact that not every sector saw slower sales. Electronics and sporting goods were in demand but this rebound after at least 4 consecutive months of softer spending is probably related to Black Friday sales.
BTW: EUR/GBP is at the brink of hitting 90 cents – a move that I called on Dec 8
Hawkish comments from ECB member Weber is driving the EUR/USD through the roof. The currency pair is up close to 2.5 percent or more than 300 pips.
After cutting interest rates by 75bp earlier this month, ECB member Weber said today that a January rate cut is not a done deal. He pointed out that the ECB has never taken interest rates below 2 percent and that the central bank doesn’t have enough info to decide on a January rate cut. Market tensions are expected to ease next year and he really wants to avoid negative real interest rates. More importantly, he added that when the economy recovers, the ECB will need to raise rates promptly.
In terms of monetary easing, the ECB has been one of the least aggressive central banks this year. They have only cut interest rates by 150bp, compared to the 325bp by the BoE. This is why EUR/GBP is moving closer to my 0.90 target.
With the Fed cutting interest rates next week, the hawkish comments from the ECB will fuel further gains in the EUR/USD going into the US rate decision – there is nothing standing in the way of EUR/USD hitting 1.35.
Forex trading ranges have exploded over the past few months. The daily average trading range has doubled for all of the actively traded currency pairs in 2008, with some currency pairs even seeing a 200% rise in their average daily range.
However the big explosion in volatility has actually happened in the past 9 weeks. EUR/GBP, USD/CAD and the AUD/USD have seen the largest increases to their average daily range, but the range for the EUR/USD and GBP/USD has also increased materially.
More specifically, in 2007, the EUR/USD had an average daily range of 84 pips. Since October, its average daily range has been 267 pips, a more than 300 point rise.
Understanding trading ranges is very important because it plays a big role in developing effective money management strategies. I explore this concept in more detail in the second edition of Day Trading & Swing Trading the Currency Market.
EUR/GBP which use to known as one the range trading currency pairs saw its average daily trading range increase from 36 pips in 2007 to 142 pips since October, a whopping 400 percent rise. Say goodbye to the days of the hiding in low volatility of EUR/GBP because it is currency pair that has seen the largest expansion in volatility.