Just how far will sterling fall?

2013 has been a grim year for the pound.

It began the year worth US$1.63. Now it’s $1.51.

It’s had a similar fall against the euro. On 1 January it was €1.24. Now it’s €1.16.

Its waterfall decline accelerated after ratings agency Moody’s downgraded Britain last Friday. But this downgrading came as no surprise, so I suspect it was already priced in.

‘Buy the rumour, sell the news’, runs the saying – though in this case the reverse applies.

The rumour got sold. So is it time to ‘buy the news’? In other words, is it time to be long the pound?

Sterling could be headed for the $1.40 level

I’d like to start with a chart of sterling over the last three years.

Sterling vs US dollar over the last three years

(Click on the chart for a larger version)

You can see that for the last two and a half years it has traded in a range against the US dollar, capped at around $1.63 – $1.64 (apart from brief sorties above in mid-2011). This cap is shown by the red band.

At the other end of the range, the $1.53 area, as shown by the amber band, has been strong support. Six times that level was been tested and six times it held.

On the seventh re-test, however, sterling ran out of buyers. The range has broken to the down side. That does not bode well.

(Incidentally, that chart of sterling looks remarkably similar to gold’s chart over the same period, which I posted last week. The difference is that gold has held – for now at least – while sterling has broken down. For all gold’s failings this year, it is actually up a couple of percent against sterling, such has been the pound’s weakness).

Coming back to the pound against the dollar, sterling has left a gap between $1.53 and $1.54. I have circled this gap in red on the chart above. Gaps have a tendency to be filled, which suggests a relief rally of sorts will come. The velocity and violence of sterling’s recent descent, coupled with strong anti-pound sentiment, are all additional arguments suggesting a bounce is likely.

But any such bounce wouldn’t go much above $1.57, I wouldn’t have thought – unless America suddenly takes a turn for the worse (possible). Perhaps it’ll only make it to $1.54-$1.55.

Longer term, I would suggest the pound is now destined for the $1.38-$1.43 zone – the green area on the chart below, a long-term chart you will have seen me post before. If $1.50 is broken, this area will act like a magnet.

Sterling vs US dollar

(Click on the chart for a larger version)

Should we get back to that green zone, the question then will be, ‘Will that hold?’

The probability, based on the evidence of the last 25 years or so, is that it will. But that’s by no means certain. Our economy is built on finance, house prices and government spending.

So the combination of a weak government, too much debt and a central bank bent on engineering a boom in time for the next election, suggests that the pound will come under severe pressure in the coming months and years.

For example, there was talk of negative interest rates yesterday from Paul Tucker, deputy governor of the Bank of England. In such a situation a central bank would charge banks to hold their money, rather than pay them interest, in order to ‘encourage’ them to lend out more. Such a policy, were it be implemented, is unlikely to be bullish for the pound.

(I thought the credit crisis was caused by too much irresponsible lending, by the way. It makes you wonder why they are trying to force more).

We’ll review the situation if and when we get to the $1.38–$1.43 zone.

Will the pound hit parity with the euro?

When we went below that green zone in the dark days of the miners’ strike in 1984-5, we almost reached parity with the dollar. It would take a crisis of similar magnitude – cuts could potentially bring it on – to take us below $1.38 once again.

Parity against the euro, however, is rather more achievable. We only have another 16c to fall to win that particular battle in the currency wars. The euro is that much harder to debase.

Here we see the long-term chart of the pound versus the euro (the 1990s numbers are based on a composite of European currencies).

Sterling vs the euro

(Click on the chart for a larger version)

At €1.16 we are already below sterling’s dark days of the early 90s. However, there is quite a strong uptrend that has developed over the four years since the 2008-9 lows. You can see that the pound has been making sequentially higher highs and lows. If this current low holds, and the pattern continues, that gives a target of about €1.32. That does not marry with my bearish sterling views, but who knows what the next phase of the euro crisis will be and what effect it will have on its currency.

Shorter term some kind of relief rally now seems to be happening thanks to the fall-out from the Italian election – we have gone from €1.14 to €1.16 in the last day or two. I’d bet that on a move to the €1.20 area. But then that this uptrend breaks and we test €1.10.

If that all sounds a bit confusing, I apologise. Pound vs dollar I’ve always found easy to read clearly. Pound-euro less so.

If you ignore the politics, Italy leaving the euro would probably be good news for the currency. Italy’s track record with government money, as anyone who has looked at the history of the lira will tell you, is not great. It would mean the loss to the eurozone of a large economy, yes, but it would also mean the loss of an economy with serious problems.

However, such an exit would be a political disaster for the European project. It would suggest the euro’s days were numbered, which, as my colleague John Stepek noted yesterday, makes it unlikely to happen. More likely is some bureaucratic compromise in the form of European Central Bank money-printing.

Until it gets to that, there will be the usual to-ing and fro-ing and grandstanding. That suggests we can expect to see a lot more volatility from the single currency in the months ahead.

If you fancy betting against the pound, I think shorting it against the dollar will give you a less hairy ride than the euro. But wait for some kind of rally before you place your bet. If you’re just worried about when you should change currency for your summer holiday on the continent, give it a few weeks.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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21 Responses

  1. 27/02/2013, JREwing wrote

    The Pound is actually worth about 40 US Dollar cents. Just my view.

  2. 27/02/2013, Changing Man wrote

    Useful analysis. Confirms the need to short the pound to offset losses in holding Sterling assets. So easy to hold ETFS 3x short GBP long USD, as part of a balanced portfolio and get in and out quickly if required.

  3. 27/02/2013, Andrew Beckett wrote

    Why don’t you use the standard EURGBP cross? – i.e. what a euro costs in pounds (currently 86.56 pence). The BBC does it the wrong way round too, but thought MoneyWeek readers would be slightly more educated.

  4. 27/02/2013, r4ffa wrote

    A well balanced article aimed generally rather than at Traders

  5. 27/02/2013, eddiegeorge34 wrote

    You have painted an alarming picture for the £, time will tell. There is hardly an English article which doesn’t associate the terms basket case, disaster, collapse, etc. with the Eurozone and now especially Italy. However, a look at 3 key fundamental statistics shows the Eurozone and Italy are much better off than the UK. They at least have positive trade balances and are not dependent on huge foreign loans to keep going and finally their budget deficits are small relative to the mushrooming UK debt. Despite all Cameron’s grandstanding and lying about financial discipline, the government deficit is growing by at least 8%/a, comparable only with the US and the worst offenders. The rating agencies have a near impeccable record of adjusting ratings far too late, but at last they realise what a farce the UK financial situation is.

  6. 27/02/2013, jrj90620 wrote

    You’re comparing junk, fiat currencies, against each other.Better to compare to money(gold) and other real assets.They all have looked better,recently,but over the long run,all will continue to decline.

  7. 27/02/2013, Colin Selig-Smith wrote

    How far will Sterling fall? …. Well how far has it fallen so far?

    1 pound was worth $391 and today is worth $1.50. I imagine it can easily continue to lose the remaining 0.4% of it’s value to total worthlessness.

  8. 27/02/2013, Boris MacDonut wrote

    #7 Colin. I know it waw worth about $4 in the 1920′s but when did it hit $391?

  9. 27/02/2013, Montmorency wrote

    You say that £-Euro is less easy to read than £-$. I agree, and I think it is for this reason:

    £-$ is a massive market, so is $-Euro, in terms of numbers of transactions. £-Euro is dwarfed by both of those.

    Thus I think most of the fluctuations we see in £-Euro are merely side effects of the massively larger Cable and $-Euro currency markets, and are thus much harder to read or predict.

    The times when this might not be the case would be when there are specific Europe-vs-UK issues going on, unrelated to the US. Rare, but may happen.

    This is my theory anyway.

  10. 27/02/2013, Colin Selig-Smith wrote

    @Boris thanks for pointing out the mistake in my calculation. A pound was worth $321, not $391. So has only lost 99.5% of it’s value so far and not yet 99.6%.

    I do still maintain it will continue to lose all value and fall to 0 or something immeasurably small. I may put some framed notes up on my wall, purely out of sentimentality.

  11. 28/02/2013, PUSSER wrote

    “@ Colin Selig-Smith = A pound was worth $321, not $391. So has only lost 99.5% of it’s value so far and not yet 99.6%.”

    Thank God for that. I was really worried reading your first post.

  12. 28/02/2013, Monty Python wrote

    And apparently the economy grew a lot stronger than we were led to believe. Once you take out the ‘olympics effect’ can anyone calculate the precise GDP ? Slide rule and calculator anyone ?

  13. 28/02/2013, Boris Macdonut wrote

    #10 Colin. When was the pound worth $321 dollars? I don’t believe you.

  14. 28/02/2013, Colin Selig-Smith wrote

    @Boris.

    A pound was 1 troy pound (373g) of Sterling (92.5% pure) silver. Today that is ~$321.

    We are talking about the devaluation of the pound and where it might stop. I posit that it won’t stop until it has lost *all* value. In fact I am 99.5% certain.

  15. 28/02/2013, Boris MacDonut wrote

    #14 Colin. When? Is what I asked, not how. I’m starting to think you make things up to suit an agenda.

  16. 01/03/2013, JREwing wrote

    Latest data shows UK manufacturing is contracting at an alarming rate. That is not what you’d expect with a weak currency which is supposed to help exports. Sterling now testing 1.50 to the US$.

    This is going to be much worse than the 1970s and most people haven’t got a clue how bad it is going to get.

  17. 02/03/2013, Colin Selig-Smith wrote

    @15. Boris MacDonut

    The history of the pound is publicly available information, is not in question, and takes just seconds to find on Google.

    http://lmgtfy.com/?q=the+history+of+the+pound

  18. 03/03/2013, Boris MacDonut wrote

    #17 Colin. Still being evasive. I asked when the pound was worth $321. You are trying to bluster.

  19. 03/03/2013, Screwloose wrote

    Boris

    When the Pound was first defined, it was for 16 ounces (avoirdupois pound pre-1526) of Sterling grade 92.5% fine silver.

    Calculating how many current GBPs – or dollars – it takes to purchase a similar quantity of Sterling silver today illustrates the continuous depreciation of the note.

  20. 03/03/2013, Boris MacDonut wrote

    #19 Screwloose. Thanks that helps a bit. But the pound was Anglo-saxon wasn’t it? It was not created in 1526. Either way the dollar did not exist until 1792 and it too was 16 ounces of silver. I just want to know when the pound was worth $321….in reality, not fiction.

  21. 04/03/2013, Boris MacDonut wrote

    I assume Colin’s silence confirms he was spinning the truth. There has never been a time when the pound was worth $321.
    What Colin wants us to accept, by a leap of faith, is that in 1526 the pound was worth 321 times something that would not be invented for 266 years. What he doesn’t tell us is the thing invented in 1792 (the dollar) also devalued by 97% in the ensuing years.
    The highest pound to dollar value ever was $5.75. Colin can spin all he likes but he ignores the fact that in the 1792 average wage was £25 a year, now it is £28,500…an increase of 114,000% !!

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