Currency Corner: what’s next for the pound sterling?

Currencies crave stability. But there's precious little of that around right now, says Dominic Frisby. So what hope is there for the pound?

190510-the-pound
173752532

Welcome back to Currency Corner. In this week's column, we consider the plight of the pound.

If you are bullish or bearish about a particular nation, the way to play that sentiment is to make bets on that nation's equities, bonds, or currency. A currency is the issuance of a national government, and so, generally, currencies are more sensitive to politics than equities. If there is one thing the forex (foreign exchange) markets do not like, it is political upheaval and instability.

I don't mean the kind such as we saw with the landslide election wins of, say, Tony Blair in the UK, or Barack Obama in the US. In both of those cases, it was perceived that political stability would follow and it did.

Rather, I'm talking about the kind such as we saw with the Brexit vote in June 2016 to leave the EU, where there is no obvious clarity of outcome.

It might seem incredible now, but in 2007, when Blair stood down as prime minister and Gordon Brown took charge as had been signposted would happen, long in advance the pound was actually trading above $2. In October 2007 of that year it went to $2.11.

Broadly speaking, it has been in decline ever since. First there was the financial crisis of 2008, then rising national impatience with Brown. The pound quickly fell to the $1.40s, losing more than 30% of its value against the US currency. The coalition government, elected in 2010, brought some stability back. At one stage in 2014, sterling reached $1.72.

But it's been falling ever since, not helped by the fact that, on the other side of the coin, the US dollar was strong under Obama.

The pound has been in a bear market for a long time

So the pound was already well entrenched in a secular (long-term) bear market when the EU referendum came. It had been sliding through most of 2015 and early 2016, reaching a low of $1.38.

When it started to look like Remain would win, there was a rally back to about $1.50. But then the British voted the "wrong" way, and the pound dropped like a stone to the $1.30 area.

However, what really did for sterling is the mishandling of Brexit which has followed. First the Bank of England's Mark Carney slashed interest rates, when perhaps he did not need to the economy was doing fine. That drove the pound lower.

Then we got prime minister Theresa May's infamous speech at the Conservative Party conference in October 2016. The "flash crash" which followed took the pound below $1.20, to lows not seen since the days of the miners' strike and the Falklands War.

Weakness in the US dollar and the perception that Brexit might actually be OK which came around the time of the prime minister's Lancaster House speech in January 2018 saw the pound rally to as high as $1.43 in early 2018.

Yet that soon passed, and bungle after bungle has followed. Since mid-2018 the Brexit impasse has seen sterling mired in a range around the $1.30 area.

The pound is cheap but it might stay that way for a while

On a purchasing power parity (put simply, comparing what it costs to buy a quantity of goods in one country, with what it costs to buy the same quantity in another) basis, the pound is cheap both against the dollar and, to a lesser extent, against the euro.

Different analysts use different measures, but the general consensus is that somewhere between $1.50 and $1.60 is fair value for the pound. We are a far cry from that today.

Against the euro, the pound currently sits at €1.15. Fair value is probably in the €1.25 area. The days of €1.70 to the pound such as we saw shortly after the turn of the century are long gone. (One day they'll come again, I suspect).

But we are not going to see "fair value" until Brexit is resolved. It almost does not matter how it is resolved, as far as sterling is concerned, as long as it is resolved.

If Parliament turned around and said: "right we are remaining and there will be no further votes on the matter"; or it voted through May's deal; or it said we are leaving without a withdrawal agreement on WTO (World Trade Organisation) terms; any of these outcomes might be unpalatable as far as your own political ideology is concerned, but at least they would bring some certainty.

The world would have a rough idea what was going to happen, speculation as to the pros and cons of the outcome could take place, and investment decisions could be made.

But while we are stuck in Brexit limbo, sterling is going to be stuck as well. When the path out becomes clear, so will sterling make its move.

I think that move will be up, for reasons I'll explain next week. But I don't see Brexit being resolved before then, so there's no rush.

Recommended

Currency Corner: As Britain leaves the EU, what lies ahead for the pound?
Pound vs Euro

Currency Corner: As Britain leaves the EU, what lies ahead for the pound?

On Brexit Day, there’s only one currency pair to look at, says Dominic Frisby – the pound and the euro. Will sterling continue to strengthen, or will …
31 Jan 2020
The charts that matter: inflation, bubbles, and booze
Economy

The charts that matter: inflation, bubbles, and booze

As US stocks head higher into bubble territory, John Stepek looks at the charts that matter most to the global economy.
23 Jan 2021
The charts that matter: bubbling over?
Global Economy

The charts that matter: bubbling over?

As markets get decidedly bubbly, John Stepek looks at the action in the charts that matter most to the global economy.
16 Jan 2021
Of course bitcoin is a bubble – a bubble you can’t ignore
Bitcoin

Of course bitcoin is a bubble – a bubble you can’t ignore

Bitcoin’s wild ride is being called a bubble by many. And it is, says Dominic Frisby. But that’s not necessarily a bad thing. And it’s a bubble in whi…
13 Jan 2021

Most Popular

Why we won’t see a house-price crash in 2021
House prices

Why we won’t see a house-price crash in 2021

Lockdown sent house prices berserk as cooped up home-workers fled for bigger properties in the country. And while they won’t rise quite as much this y…
18 Jan 2021
Inflation is the easiest way out of this – just don’t expect politicians to admit it
Inflation

Inflation is the easiest way out of this – just don’t expect politicians to admit it

The UK government borrowed £34.1bn in December, a record amount for that month. Britain's debt pile now amounts to 100% of GDP. How are we going to pa…
22 Jan 2021
When will the US stockmarket bubble burst?
US stockmarkets

When will the US stockmarket bubble burst?

With US stocks more expensive than before the Wall Street crash of 1929, there are growing signs of “mania”. But what will push markets over the edge?
22 Jan 2021