Will the pound fall below parity with the US dollar?

“The pound is headed to 90c against the dollar”, says Paul Thomason of the Elliott Wave Market Service.

That’s a prediction that’s bound to get every UK investor’s head turning.

And if January 2013 is anything to go by, he may have a point. The pound has gone from $1.63 to $1.57 in just a month. That may not seem like a lot, but in the currency wars, it’s no insubstantial number.

But 90c? Really?

The pound looks well placed to win the currency wars

Just about every country in the world is trying to get the value of its currency down. Just about every country is trying to make its exports competitive and devalue its debt. It’s why we keep hearing that phrase, ‘race to the bottom’.

But the UK – with its debt, deficits, unfunded liabilities, reliance on the financial sector, lack of exports, weak government, low growth, stagnant housing market and increasing social unease – looks well-equipped to win this currency war.
So how low will it go? We start with a long-term chart, showing sterling v the dollar since 1986. You can see there is a consistent range over time. The red area – around $2 – is the obvious, longer-term sell zone. The green – around $1.40 – is the obvious buy zone. 

Chart: The pound since 1986

The amber area – between about $1.63 and $1.70 has been a barrier, either one of resistance during times of pound weakness, or support during times of strength.

The green zone survived the aftermath of Black Wednesday, George Soros’s raid on the pound and its withdrawal from the European Exchange-Rate Mechanism in 1992/93. It survived the repercussions of the dotcom crash in 2000/01. It even survived Gordon Brown and the stock market crash of 2008/09. Based on the evidence of the last 27 years, it’s not easy to push the pound much below $1.40.

In fact, the only time this green area hasn’t held pre-dates this chart. It was in 1984-85 during the unrest of the miners’ strike. The pound had been wavering just below the $1.40 mark for several months when, in late June 1984, it slid below. It made its way lower for a period of several months, before reaching an eventual low of $1.04 on February 26, 1985. 

By the following July it had made it back into the green zone, where it meandered upwards until 1986, when the chart above begins.

I therefore suggest that, for that 90c target to be reached, we need some fairly historical domestic unrest and upheaval to trigger it. It’s not as though there’s a shortage of potential sources of this. Increasing tension over government cuts could easily boil over and morph into something bigger.

But something on the scale of the confrontation of 1984-85? I wouldn’t bet on it. Not just yet, anyway. This government tends to back down and pander in the face of confrontation in a way that Margaret Thatcher, rightly or wrongly, never did. Its strategy has proved to be one of can-kicking.

So where will the pound fall to?

But what about that green zone – the $1.38 to $1.43 area? Can we expect the pound to slide to there? That I would suggest is rather more likely, although by no means a done deal.

Here is a chart of the pound since late 2008. I have drawn in blue a trend line of the crash lows. We are sitting on that trend line now. It may well bounce from here.

Chart: The pound since 2008

The hammering it has taken this last month is not so unusual. It took a similar beating in May last year and in August-September 2011. On both occasions it found support in the $1.53-$1.54 area.

Based on the range of the last two years, it’s likely it will do so again. In fact the range is pretty well established. Look to sell the pound around $1.63, or perhaps a little higher, and buy it back at $1.53.

However, if the red zone above does not hold – and I guess it would take some bad news, or rather the rumour of bad news – we could go a lot lower. I say rumour, because this current slide has been driven in part by the threat of various ratings agencies back in December to downgrade the UK’s credit rating.

Indeed, you might find that in the event we are downgraded – should the pound already be down in the dumps – that it actually rallies, true to ‘buy the rumour, sell the news’ form.

So my prediction is this: sterling will fall a little more in the short term, but not as far as the bears might think. For now, that red zone will hold. It will continue to trade within the range it has established over the last couple of years. The currency is badly flawed, yes, but so is every other currency – which means there is a limit to how far it can fall against them.

For that red zone of support to fail, some kind of proverbial needs to hit the fan, I would suggest. But let’s face it, there’s no shortage of proverbial floating about out there! So while my advice to shorter-term traders is that the red zone might hold for now, I can certainly see it being shattered in the longer term.

My colleague John Stepek has more on the currency wars in general in the next issue of MoneyWeek magazine, out on Friday.

Follow John on Twitter || Google+ John Stepek

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  • Chester

    The Elliott boys have generally been right in terms of direction and degree, but without a crystal ball, timing is an open issue

    The key is their benchmarking against the US$, which is likely to do well against all assets as deleveraging intensifies. This will have little to do with underlying value or confidence in Sterling, as most other currencies will fall accordingly. Sterling should be weaker than say the NOK or $SNG based on fundamentals, but hold up well against the Euro and others

    The US$ will gain as dollar denominated credit deflates, the rush to safety intensifies, and the value of cash rockets. The $90c target could be reality in 2015, when Elliott believe we will have hit bottom. Holding US$ in cash could be a sensible hedge

  • Pete Comley

    Like you I suspect 1.40 area may well hold with a decline, but a decline further is no so improbable as you make out.
    The graph you show only covers the 30 year period of this range bound exchange rate. A better graph would have been to show what has happened since Nov 1967. If you look at that graph, the pound has been in a downward trend with some sideways consolidation in recent decades. That is quite a different perspective to the one you present and leads to a different conclusion.

  • Gossage

    As we’re no longer the reserve currency we’re on thin ice. But then in the slaughterhouse we may look better than euro, except the significance of Brown’s bottom may return to haunt us when the tide goes out.Maybe a good enough reason to join(?) or will £ be pushed to hyperinflate? Can someone remind me the first law of the treasury?There are some very tough times ahead.

  • Roger

    Just look at another currency, the RMB, currently 6.22RMB to 1USD, the US admin wants it to go to 4:1 (usually US wins in this game), so the ultimate target for GBP against RMB (down all the way from 15:1 to 9.8: 1 currently), are you talking about also 4:1? then I think many people know what that means.

  • Martin

    “Based on the evidence of the last 37 years, it’s not easy to push the pound much below $1.40”.

    1986 – 2013 is actually 27 years and if you go back to 1976 to make it 37 years you will see that the pound did get close to parity with the dollar at times in the 1976-1980 period. I seem to recall it also went to £1 – $2.40 as well, it was an extremely volatile market.

  • chris

    There is nothing more unwise than drawing trend lines on the FX charts – particluarly as FX is so non-linear, with the array of multi-currency interdependencies. As such I would not even use support/resistance level lines for these reasons, which I would use for the share charting.

  • aff

    So ‘winning’ the currency war means the first to turn into toilet paper?

    I hear the excuse that devaluation of currencies is to boost exports. This is false, the real reason is to try and devalue the government debt. Of course its the savers who suffer. (Unless you save in real money, gold and silver)

  • IJ

    Gossage says: “But then in the slaughterhouse we may look better than euro”. why? If you look at the numbers instead of reading the drivel the English papers write, the UK is worse than Europe on just about any measure.

  • Terry Bradford

    Devaluation may boost exports but as aff points out the main purpose is to reduce our indebtedness. This can backfire as foreign investors in anything from football clubs to pty see a fall in the value of these investments and take their money elsewhere.
    An attempt to reduce the price of assets such as domestic and commercial pty would be more effective in increasing our competitiveness. This could be done by increasing base int rate. At present this is unlikely as any drop in house prices would cause GDP to fall. But is current gdp more important than trade deficit. GDP measures the total national economic activity.As a trading nation we depend on income from products and services. Get this in surplus and govt can then takes measures to increase GDP. The first hurdle is to increase foreign income.

  • Marc Authier

    Time for England to pay for its bankster’s crimes. Minus 50% to 60%. Never mind parity. Its going much much lower that parity because UK is Greece on steroids. Pay back time for your monertary crimes England !

  • Jack

    Chester (above) is on the money. While you write with a focus on what might go wrong with the UK, you have ignored what might cause the US$ to rise.

    In the event of large debt liquidation, since most of the world’s debt is denominated in US$, that currency will be in demand, as that is the currency that will be needed to repay the debt.

  • aff

    It is very clear that the entire problem starts with central banks (although you wouldnt think it if all you listen to is mainstream news). Its time for the madness to end and get rid of central banks. Lets not waste this crisis.