December Currency Update

The pound has been looking sickly since the summer. It has done well enough against the US dollar, which has had its own generous share of trials and tribulations, but against the euro it spent the bulk of September and October heading south. Then it stopped. Why did it happen and does it represent a turnaround in sterling’s fortunes?

First, look at why the pound spent the last two months under the cosh. Investors were selling US dollars. To sell them they had to buy something in their place. Equities and commodities are always an option of course but for anyone wanting to stick to good old money the easiest and most liquid alternative to the dollar is the euro. The euro went up and the pound was left behind. As well as the technical reasons, investors had other motivations for staying away from the pound. Its two demons were the risk of a slowing economy and the threat of quantitative easing.

Since its election in May the coalition government has made it abundantly clear that to get rid of its inherited structural deficit will mean a period of austerity for all. Investors feared that sharply reduced public spending would mean job losses and a plunge in household spending that might push the economy back into recession. They also worried that another round of quantitative easing by the Bank of England would dilute the value of the currency, sending it lower. The first concern came true when the chancellor confirmed in his spending review that half a million jobs would disappear in the public sector and accountants Price Waterhouse Coopers predicted the loss of another half million at private companies. As for quantitative easing, one member of the Monetary Policy Committee voted at the October meeting for another £50 billion of it. Things looked bleak for the pound…

…until, with a single bound it was free. The provisional estimate for gross domestic product (GDP) in the third quarter of the year was that it grew by 0.8%. The figure was twice as big as the 0.4% that analysts had predicted. Taken together with the previous two quarters’ 0.3% and 1.2% it meant that Britain’s economy grew by 2.3% in the first nine months of the year. The news coincided with an announcement by ratings agency Standard & Poor’s that it had reaffirmed Britain’s AAA credit rating.

So sterling got a result from the GDP data but that does not guarantee its longer term success. The chancellor’s spending review will be tough framework for the economy to live with. Job losses and spending cuts are not an obvious recipe for growth. Mr Osborne hopes the private sector will take up the slack but nobody will be entirely convinced that it can until they see evidence of it happening. The one positive aspect that ought to linger for the next month or so is that the Monetary Policy Committee will find it hard to justify a fresh round of quantitative easing with inflation above its target range and the economy still pushing ahead.

The GDP data, together with a reaffirmation of Britain’s AAA credit rating, mean sterling is off the hook for the moment. But although it has won the battle it has not yet won the war.

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This entry was posted on Tuesday, November 30th, 2010 at 11:11 am and is filed under Currency Exchange . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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