The British pound was hit badly during February and also in March. A combination of weak figures from the UK and a sweep of the dollar sent it plunging down.
After consolidating above 1.50, can the pair resume the falls? Not so fast. Contrary to many other countries, a weaker currency doesn’t help the economy too much. In addition, the transition period in the BOE, the dilemma of the government and the euro-zone crisis all paint a mixed picture.
* This article is part of the April 2013 monthly forex report. You can download the full report by joining the newsletter in the form below.
Economy
- The British economy returned to contraction in Q4 2012 after only one quarter of growth. The strong Q3 growth is now clearly attributed to the Olympic Games. Signs emerging during Q1 2013 point to another quarter of contraction, cementing the triple dip recession, even though not all of them are that bad. A first estimate of Q1 growth is scheduled for the end of the month.
- Forward looking PMIs haven’t been that good: manufacturing fell again below the 50 point mark separating growth and contraction to 47.9 points. Construction deepened its drop to 46.8 points. However, the services sector is still growing according to Markit: 51.8 points in February.
- Jobless claims, which saw a few months of improvement, disappointed in February with a drop of only 1500 people. The unemployment rate remained stable at 7.8% in January.
- Retail sales fell by 0.6% in January but rebounded strongly, 2.1%, in February.
The weaker pound doesn’t seem to help the British economy. The disadvantage of a weaker currency is that imports are more expensive: Britain’s Consumer Price Index is on the rise again, getting closer to the upper band of the range: 3%. CPI rose to 2.8% (annually).
Dilemmas
So, the Bank of England has a tough dilemma: adding more monetary stimulus in the shape of expanding the QE program, or leaving policy unchanged in order to keep inflation under control?
The central bank has already warned about the weakening of the pound.
The dilemma caused a split in the MPC, with 3 members voting for more QE and 6 voting against. The outgoing governor Mervyn King was one of those voting for QE, and he was outvoted. His influence is waning off.
The incoming governor of the BOE and currently governor of the BOC Mark Carney will enter his position only in July. So, until Q3, it is hard to expect any significant policy changes, unless an extraordinary event hits the markets.
Also the British government has an ongoing dilemma regarding its austerity policy. On one hand, this policy contributed to lower borrowing costs, together with the central bank’s bond buying and the inflow of euro-zone money.
On the other hand, the never-ending economic drag is making the government unpopular. In addition, this policy wasn’t enough to maintain the UK’s perfect triple AAA ratings: after the downgrade by Moody’s, the UK doesn’t have 9 As.
Euro-zone inflows
Greek money fled the country and found its way into the UK as the crisis intensified. Money of rich French people also made its way to the UK as the government wanted to impose higher taxes. And now, after the crisis in Cyprus, many Europeans could fear about the safety of their deposits in banks.
And once again, the British pound can benefit from this, as a regional safe haven. Yet again, this inflow also has some negatives: prices of homes in London are once again at sky high levels. British bonds don’t yield too much, so property in one of the world’s most important cities is seen as a good alternative.
All in all, the pound is likely to look for a direction in April. The key factor for decision making will be the GDP report late in the month. Beforehand, the euro-zone jitters are expected to have the biggest impact.