Does the Bank of England Want a Weak British Pound?

By: Seven_Days_Ahead

After a steep sell off against both the Dollar and the Euro in the wake of the financial crisis, the Pound began to bottom out during the 1st quarter of this year, as it became evident that other G7 economies were doing as badly as the UK, if not worse.

As the 2nd quarter evolved, and data began to steady, with the PMI services survey showing solid improvement away from the lows, expectations turned towards an early UK economic recovery, which was borne out by improving data coming from the housing market.

Where only a few months earlier, analysts were predicting the housing market correction would extend into 2010, suddenly the Nationwide and Halifax house price surveys were throwing out readings showing sporadic month on month price increases.

While at first these were dismissed as a blip, subsequent reports have confirmed the housing market is in a recovery. However, the optimism over the UK economy took a serious knock when Q2 GDP released in July, came in much worse than expected, albeit a big improvement on Q1 and Q4 2008.

The Pound began to consolidate its recent gains, even though business investment showed unexpected weakness too. But what has worked against the Pound over the last 6 to 8 weeks is the Bank of England.

After initially announcing at the July MPC meeting, there would be no increase of its QE program, against market expectation, policy makers reversed their decision in August, but not only did they increase QE, but by double the amount expected; £50.0B instead of the £25.0B anticipated. This knocked the Pound against both the Dollar and the Euro, but worse was to come. In spite of a continuous steady stream of data showing the economy recovering, the August Bank of England quarterly inflation report, once more sought to play down the obvious, albeit fledgling, economic recovery, once again undermining Sterling.

More was to come, King has recently publicly flirted with the idea of reducing interest paid on Bank balances held at the Bank of England, as a means of forcing the Banks to stop hoarding cash and lend it. This hasn’t yet been implemented, and recent minutes show no discussion has been held, but the market having been surprised twice during the summer, took the rumours seriously and again the Pound suffered as such a move was considered another form of monetary easing.

However, after no surprises were sprung by the recent September meeting or minutes, the Pound again tried to recover, but once again governor King has popped up and in an interview has intimated the Bank would be comfortable with a weaker Pound.

While this has merits for the much reduced manufacturing sector, it acts to drive up import costs, especially oil, which has enjoyed a strong rally over recent months, and acts to offset domestic disinflation.

King may see this as a means of holding deflation at bay, but the official CPI stands at 1.6%, against a target of 2.0%, so hardly deflation.

We judge the Bank is trying to hold down the value of Sterling as a means of providing monetary stimulus, while making UK assets look attractive for foreign investors, but for traders a strong Pound looks a thing of the past.

Mark Sturdy
John Lewis

Seven Days Ahead
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Mark Sturdy, John Lewis & Philip Allwright, write exclusively for Seven Days Ahead a regulated financial advisor selling professional-level technical and macro analysis and high-performing trade recommendations with detailed risk control for banks, hedge funds, and expert private investors around the world. Check out our subscriptions.

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