Over the past 2 weeks, the British pound has soared more than 8 percent against the U.S. dollar. Like many countries around the world, the U.K. has succumbed to higher gas prices but unlike some other countries, the weakness of the British pound has exacerbated the rise in inflation. Hotter consumer prices helped to fuel today’s gains in the British pound, but it was comments from Bank of England Governor King that took the GBP/USD above 1.47. Quantitative Easing has been kept a lid on gains in the pound, causing it to under perform currencies such as the euro. The CPI numbers are significant however because annualized CPI is now BACK ABOVE the BoE’s 3 percent target.
However this morning, BoE Governor King talked UP the pound, which is a dramatic departure from his previous comments. He said that there is “no reason why the sterling should go any lower” and that the sterling’s fall was not engineered. He also said that the central bank originally aimed for GBP75bn of Asset Purchase Facility over 3 months but “might need to do less if it works.” These positive comments are probably a reaction to the recovery in the equity markets and the recent drop in bond yields.
The 1.4650 level in the GBP/USD is fairly significant (100-day SMA). If the currency pair manages to hold above that level, the next area of resistance is 1.50.
The Euro and British pound have come under severe selling pressure after the ECB and BoE cut interest rates by 50bp. Interest rates are now at historic lows for both central banks and even though the rate announcements were negative for both currencies, the Euro has sold off more aggressively than the British pound because ECB President Trichet warned that growth will be signicantly reduced in 2009 and 2010 while inflation will remain well below 2 percent.
More importantly, he admitted that the ECB is studying non-standard measures which include quantitative easing. However, Trichet prefers to use the Fed’s label of credit easing over quantitative easing (What is the Difference Between Credit and Quantitative Easing?). The mere possibility that the ECB could consider Quantitative Easing was enough to drive the EUR/USD below 1.25. With the third highest interest rate of the G10 nations, further interest rate cuts are still possible. By saying that they have not made a decision about whether 1.5 percent is the lowest level makes 1 percent interest rates a real possibility for the Eurozone. In fact, Trichet may opt for another rate cut before credit easing. For the US dollar, British pound and Japanese Yen, no surprises are expected from future rate decisions. However for the Euro, the prospect of lower interest rates and the uncertainty of if and when the ECB will adopt credit easing should keep the EUR/USD under pressure.
Bank of England: Rates May Have Hit Rock Bottom
As for the Bank of England, I believe today’s 50bp rate cut to 0.5 percent is their last. The central bank has been worried that excessively low interest rates would erode profitability of banks, reducing their incentive to lend. Now that they have been given the authorization to begin Quantitative Easing, it will be their new focus. UK Gilts have soared on the announcement that the government will purchase up to £100bn in Gilts and £50bn in private sector assets (syndicated loans and ABS). As we indicated in our ECB and BoE preview, Quantitative Easing is negative for a currency, but if the BoE is done cutting interest rates, further weakness in the British pound may be limited.
The currency and equity markets are turning lower after a strong rally on Tuesday. In my Daily Currency Focus, I talked about the 3 reasons why the currency market rally was suspicious. None of the reasons for Tuesday’s jump delivered real solutions. The market only rallied because Bernanke delivered no surprises. President Obama’s attempt at reassuring Americans also failed to comfort investors.
Instead we are faced with a weakening economy that is only confirmed by this morning’s plunge in existing home sales. Sales of existing homes plunged 5.3 percent to a 12 year low in the month of January. The housing market remains the Achilles heel of the US economy as prices fall and demand wanes. The median price of a home sold dropped 14.8 percent compared to the year prior. Such disappointing numbers are not much of a surprise given the big decline in housing starts and building permits. With banks and mortgage lenders reluctant to lend, even potential homeowners with sufficient capital have found difficulty attaining loans.
The British pound has been hit the most because Bank of England member Barker said that the weak sterling is helpful. UK officials have taken every opportunity to talk down the currency.
USD/JPY on the other hand remains an animal. Despite weak economic data and a turn in equities, the currency pair continues to rise.
My favorite is still the Australian dollar because of strong M&A flow, higher gold prices and the prospect of the country remaining recession free. The AUD/USD is also prime for a breakout.
The British pound hit a high of 1.4605 this morning after falling to a low of 1.4137 yesterday. Although we have a mild improvement in risk appetite that is helping to propel the GBP, CAD, AUD and NZD higher, 2 stories making the wires are responsible for the volatility in the British pound.
Story #1 : Darling to Get Attacked Over Sterling Slide
The main story behind the British pound rally during the early European trading session was talk that European finance ministers will be attacking UK Chancellor Darling over the sterling’s slide. Over the past 6 months, the British pound has fallen more than 20 percent against the Euro and close to 30 percent against the US dollar. The most dramatic slide has been seen in GBP/JPY which dropped 55 percent.
Story #2: HBOS Expected to Report a GBP8.5 billion Loss
However some of the gains in the British pound were erased beginning around 8:40am this morning after news broke that Lloyds Banking Group expects HBOS to report a GBP8.5 billion loss. Remember that the UK government owns 43% of Lloyds so a loss for Lloyds means a loss for UK taxpayers.
Impact on British Pound
The threat of criticism at the G7 meeting should limit any further losses in the British pound. However, once the G7 meeting is over, we could see short term weakness in the pound. The Quantitative Easing that the BoE is expected to undertake should drive EUR/GBP towards parity.
There has been a lot of volatility in the foreign exchange market this morning, driving currencies to historic levels:
GBP/USD – 23 Year Low
USD/JPY – 13 Year Low
NZD/USD – 6 Year Low
EUR/JPY – 6 Year Low
CAD/JPY – 13 Year Low
GBP/JPY – Record Low
NZD/JPY – 8 Year Low
The most significant moves have been in the British pound, which fell to a 23 year low against the US dollar and in USD/JPY, which fell to the lowest level in 13 years. Comments from former Fed Chairman Volcker triggered a wave of risk aversion that led to a technical break in the currency market. He said “we are in serious recession, with no end clearly in sight.” Although there is no question that the US economy is in trouble, by saying that there is no end in sight means that there is no hope which coming from the chairman of Obama’s newly formed Economic Recovery Advisory Board is significant. By saying that he does not an end to the recession is certainly not good advice. Treasury Secretary Nominee Geithner expects an Obama economic stimulus plan to be released in the next few weeks but unfortunately Volcker’s comments overshadowed the prospect of a stimulus plan. Yesterday’s sharp sell-off made investors nervous but Volcker’s comments pushed them over the edge.
We are continuing to see flight to safety into the US dollar and Japanese Yen. Investors are looking to hide in the lowest yieldind currencies.
We also had comments from ECB President Trichet and SNB President Hildebrand. Trichet defended the ECB’s monetary policy and said they haven’t decided if 2 percent is the lowest level for rates.
Intervention by Swiss National Bank?
The Swiss franc collapsed after SNB Hildebrand said that the central banks is considering selling francs to halt the currency’s gains. With interest rates already at 0.5 percent, they have no room to ease monetary policy. Therefore they may have to resort to fixed rate currency intervention.