Here’s why the pound could be heading back to the $2 mark

Pound v dollar © Getty Images
$2 is a realistic target for the pound

The pound’s bull market continues. It had another good week last week.

However, on Monday it made a breakthrough that went, as far as I know, unreported.

It’s a breakthrough that, in my opinion, has set it on the path to $2.

A major breakthrough for the pound

We’ll start with my favourite sterling chart. It shows the price action of the pound sterling against the US dollar since 1986.

For all the volatility of the foreign exchange (forex) markets, it’s actually a pretty consistent pattern in the long term.

Broadly speaking, the pound is a ‘buy’ when it’s in the green zone – around $1.40 – and it’s a ‘sell’ when it’s in the red zone – around $2.

GBP/USD currency chart

What concerns us today is that pivotal yellow area in the middle of the range, between $1.60 and $1.70.

During periods of sterling weakness, such as the 1990s and the early part of this decade, it has been a barrier of resistance. But during periods of strength, such as the late 1980s and early 1990s and the 2010s, it has provided support during sell-offs.

And here’s the thing: on Monday, sterling broke above $1.70 for the first time in five years.

$1.70 is a price I’ve been harping on about for some time now. My line of thinking has been that, if sterling can break above it, it is headed to two dollars – or, to be more specific, $1.98 – the start of the red zone.

There is very little resistance – very little to stop it, in other words – between $1.70 and $1.90.

It might take a year or more, but it is now a realistic target, in my view. Any such suggestion even a year ago when the pound was trading below $1.50 would have seemed ludicrous. But a quick look at the habitual price patterns of ‘cable’ (the pound v the dollar) shows that when it goes, it goes.

Looking now at this ten-year chart below, I have drawn a horizontal blue line at the $1.70 price level. You can see how pivotal it is. It was support in the 2000s, and it was where the bounce following the 2008 sterling crash ran out of steam.

GBP/USD currency chart

What I like most about the sterling chart now is that there is a nice clean trade set up here. Be long – and have your stop-loss just below the blue line. Perhaps just below $1.67.


Sign up for a 4-week FREE trial of MoneyWeek magazine

MoneyWeek magazine signup

"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd


How politics could affect the pound in the coming year

Of course, there are two sides to this story. Sterling’s strength is as much, if not more, about US dollar weakness.

When stock markets are strong, sterling tends to be strong as well – it represents an economy based, for the most part, on financial assets. The dollar, meanwhile, tends to be weak. But as soon as stock markets sell off, the dollar becomes the go-to asset.

Sterling’s break above $1.70 could be telling us that stock markets are headed even higher. As for the dollar’s weakness, it seems the forex markets still don’t really believe all this talk of tapering.

But there are two political events in the UK in the year ahead that might have an effect on the price of the pound.

First, of course, there’s the Scottish independence vote. I think the pound wins either way. A ‘yes’ vote would cause volatility, of course. But, ultimately, I think it would lead to increased pound strength because of the relief it will bring to spending obligations. The more likely ‘no’ vote will not change anything – it will just be more of the same – the same fundamentals that have forged this upward trend will remain.

Then, second, there’s next year’s general election. The outcome of that, if you follow the polls, is anyone’s guess. Mine is that Brand Dave will be more appealing than Brand Ed to wavering voters – and so Brand Dave will come through somehow.

I guess the pound will continue to like that. It has so far: it was $1.40 when Cameron became PM. But who knows? Perhaps we will end up with a Labour-Ukip coalition. I doubt forex markets would look favourably on that.

This all assumes a Scottish ‘no’ vote of course. A ‘yes’ vote would probably mean England having the Tories for the foreseeable future. Markets like political stability, and they’ll appreciate the pound if the government is relieved of Scottish spending obligations.

So that’s all very interesting and very speculative. But ultimately it’s all about the price action – and the trend is higher. For the time being, sterling doesn’t seem worried about electoral outcomes, and it marches ever higher.

But beware – it’s all about financial assets and the stock market. As long as they remain strong, the pound will remain strong too. And if they turn down (and despite higher prices I’m still reading a lot of bearish sentiment), so will sterling.

But for us Brits, America’s becoming a cheap country to visit again. Hooray. I think I know where I’m going to spend some holidays later in the year.

As for all those Americans who own des-res pads in Kensington, some of them might be very tempted to sell. In fact, pound strength will not only deter foreign buyers, it will tempt existing foreign owners to become sellers. So perhaps London property might start to become more affordable to the natives again too.

This article is taken from our FREE daily investment email Money Morning.
Receive our thought-provoking investment email every weekday morning plus occasional promotions & become a smarter investor.

Please enter a valid email address

To sign-up enter your email address.




• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

Our recommended articles for today

This corporate matchmaker helps companies find new ideas

This small-cap company aims to match its clients with academics and researchers hoping to identify the next big thing. It’s one to keep a close eye on, says David Thornton.

The mansion tax: opening the door to corruption and distortion

A mansion tax may not be designed to distort Britain’s housing market, says Merryn Somerset Webb. But that’s exactly what it will do.

9 Responses

  1. 02/07/2014, Hedge against the falling $US Dollar wrote

    I am currently buying Gold Mining ETF’s and paying dollar premiums (through Wall Street).
    Should the pound become very strong against a falling dollar is this good or bad.
    Regards
    Mike Harvey

  2. 02/07/2014, SteveN wrote

    No mention of a large amount of UKIP MP’s in 2015 influencing the outcome of the resultant government/coalition. Get your head round it, Dominic, there’s a revolution happening in British politics. The people are fed up with the EU’s influence on this country, and even more fed up with the failed old parties that have betrayed the interests of the British people. With a peoples government in Westminster, this country is going to take off again, with or without Scotland. It would obviously be preferable that Scotland stayed part of the UK, but its not the most important issue. 2015 may be the last chance (as far as the EU are concerned) for the UK to leave the EU amicably. The implementation of all the treaties in 2017 will relegate national governments to the roles of Councils.

  3. 02/07/2014, tuesday wrote

    Hold on a minute! I thought the pound was ‘doomed’?

  4. 04/07/2014, CaptainPeacock wrote

    RE: ”Hold on a minute! I thought the pound was ‘doomed’?”

    It is BUT…only after it hits 1.9898 LOL!

  5. 10/07/2014, Warun Boofit wrote

    I have noticed a trend in my email inbox over the past few months, the moneyweeks end of Britain (and China its over) emails are in a downward trend being replaced by emails with a more sunny outlook. If the dollar falls to 0.5£ then I assume that oil will rise but we have numerous possibilities of a glut in production that should keep the lid on it, I dont see 150 dollars a barrel anytime soon. Cheap oil and cheap dollars and maybe the DOW hitting 22000 and the FTSE 10000, might be a good theme for a new round of moneyweeks emails, you just need to flesh it out with a good story like the end of Britain was, I like a good read that stumulates my brain even if its fantasy, come on go for it.

  6. 11/07/2014, CityFarmer wrote

    Good article makes an excellent case for buying London property!

  7. 14/07/2014, Borderer wrote

    Are we crazy even giving this nonsense any credibility at all ? Check out http://www.rickferri.com/blog/economics/93-ways-to-underperform-the-market/

    Every single article you will ever see says “last performance is no guide to the future”. No truer words have ever been spoken.

    Here we have a blue line on some chart, purporting to predict the future based on the past!

    Get a grip.

  8. 17/07/2014, Boris MacDonut wrote

    Pound should hit $2 by about 2019.Two years after the lost decade we should be back to 2003 levels.

  9. 18/07/2014, Borderer wrote

    Boris, maybe it will, and maybe it won’t. But will that be 2003 pound v 2003 dollar, or 2019 pound v 2019 dollar? Without adjusting both currencies for inflation, interest rates and other economic factors no meaningful prediction makes sense. At its simplest, how long do you have to work/invest to earn how many pounds to buy a loaf of bread in USA dollars in 2003 v how many in 2019?

    Or, to save yourself that kind of effort, draw a blue line on a chart like Dominic, and get paid for it!

    Or be even more accurate, and make it a green line.

    And, for the ultimate level of accuracy, colour it red!

Comment on this article

MoneyWeek magazine

Latest issue:

Magazine cover
A new dawn for energy

Our experts pick the stocks to buy

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

FREE REPORT:
What you should really do with your money (2014 Edition)


How to buy and sell penny shares

A beginner's guide to investing in gold

How to invest in British fracking