Can Sterling’s Strength Continue?

By: Seven_Days_Ahead

We have argued over recent months in the Macro Trader’s guide that Sterling was oversold during the financial crisis and subsequent recession. We judged the UK economy fared no better or worse than most other leading developed economies.

MONTHLY  CHART The wide context of cable is clear and well-structured: within the immediate trading range of 1.36-1.70 a triangle has formed – look closer.

WEEKLY CHART Of course, Triangles are typically continuation patterns, in this case a bear continuation pattern… But not always and the close approach to the upper falling diagonal boundary (currently at 1.6170) is intriguing. As is the possibility that that diagonal might be regarded as the Neckline of a bull Head and Shoulders pattern. The slope of the neckline is a weakness of this interpretation, but if 1.6170 were overcome a completed bull H&S would be plausible. Look closer still.

The Macro Trader’s view:
We have argued over recent months in the Macro Trader’s guide that Sterling was oversold during the financial crisis and subsequent recession. We judged the UK economy fared no better or worse than most other leading developed economies.

What seemed to rattle investors most about the UK wasn’t the actual Debt-to-GDP ratio or even the Deficit-to-GDP ratio that emerged as a result of the recession, but rather the speed and degree of deterioration compared to the UK’s peers.

Now though, the UK has taken some harsh and difficult steps to cut both the budget deficit, structural deficit and control the national debt. The worry is the measures adopted might prove too strong a medicine for the economy to handle and risk falling back into recession.

This fear is a potential negative for the Pound, but right now Sterling is enjoying a period of relative strength against the Dollar and to a degree the Euro. There are several reasons for this, some are domestic others are not. The main reasons though are;

• The level of UK inflation over the last 2 years has or so proved consistently worse than the Bank of England’s quarterly inflation report forecast,
• UK Interest rates are now forecast by independent analysts to rise this year to control inflation despite fears of a potential economic slowdown,
• US interest rates look set to remain low for an extended period as the Fed tries to nurture the US economy back to health,
• US public spending is still running at the crisis levels previously seen in the UK, with a budget deficit to GDP ratio around 10 - 12% and a debt to GDP ratio fast approaching 100% and in the absence of a policy change, won’t stop there,
• US inflation is running at very low levels and looks contained leaving the Fed free from pressure to tighten policy.

So does this mean the Pound is already clawing back the losses it previously suffered on the way back to a more realistic level? One that reflects Sterling’s purchasing parity (about 1.7000 -1.7500) or is this rally a false dawn and if so why?

While we would like nothing more than to be able to proclaim a new bull trend is in place for Cable, we feel unable to do so. While there are very real concerns about the short term path of inflation, which is currently forecast by independent analysts to rise to between 4% – 5%, we judge the factors behind the run up are either one-offs like the VAT hike or are a result of higher energy and food costs which originate abroad and cannot be easily controlled within the UK economy simply by hiking rates.

We also hold the view that the economy will slow this year. Unemployment is forecast to rise by around 250k. The government hopes the private sector can absorb most of the public sector workers displaced as a result of the spending cuts, but so far there is scant evidence for this.

Our current view of Cable is that the Pound isn’t yet sufficiently free from uncertainty to allow it to fully recover. Until there is greater clarity about the economy’s ability to weather the current fiscal retrenchment, we judge the Pound is likely to suffer a correction lower, before the big rally begins, so the recent high may be it for a while.

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 techni44cal 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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