A turning point for sterling? Don’t bet on it

Sterling had a rare good day yesterday.

The pound went from around $1.49 against the US dollar to above $1.51 this morning. That’s quite a big jump over such a short period of time.

What happened? Well, Bank of England boss Sir Mervyn King came out and said he thought the pound had fallen far enough. He also sounded more upbeat on the economy than he has in quite some time.

King of course is in charge of monetary policy. So if he’s feeling cheerful, you’d think that would be good news for the pound.

So is this a turning point for sterling?

I wouldn’t bet on it…

Sir Mervyn King talks up the chancellor

As Chris Giles puts it in the FT, Mervyn King has “sounded the alarm over sterling’s vertiginous fall.” Last night, King told ITV News that “we are moving to a properly valued exchange rate. I think we’re probably there.”

As for the Bank of England’s views of the currency: “We’re certainly not looking to push sterling down. We’re looking to ensure recovery in the UK economy and gradually bring inflation down back to our 2% target.”

He also backed George Osborne’s strategy of trying to cut the budget deficit, while leaving the heavy lifting to the Bank of England.

All very reassuring. No wonder the pound has been enjoying a bounce. But I wouldn’t take it all too seriously.

As with any political figure – and the governor of the Bank of England is a political figure, make no mistake – you can’t just take King’s words at face value.

The Budget is coming up next week. Osborne is under a great deal of pressure to persuade the country that his strategy is working. The last thing he needs is to stand up on Wednesday, against a backdrop of a panicky, plunging pound, and a Bank of England that seems in disarray.

He needs all the help he can get. So it’s nice to have a heavyweight like King throwing his weight behind the ‘austerity’ plan. Particularly as it seems that Osborne’s biggest idea will involve some sort of relaxing of the Bank of England’s inflation target.

This might seem cynical. But if King really has decided that the British economy is on the road to recovery, he must have changed his mind pretty quickly. A few months ago he was all in favour of more quantitative easing. And given how bad the recent economic data has been, it’s hard to see what could have changed his mind.

So I’d say this is more a little ‘jawboning’ to help the chancellor out before his big day.

The truth about the pound rally

So why has the pound rebounded? The simple answer is – it was due a rebound. Nothing goes down in a straight line, although sterling has made a heck of a good attempt at it over the last couple of weeks. 

As Jamie Chisholm pointed out in the FT earlier this week, the pound was starting to look oversold. According to Lloyds Bank: “Net GBP short positions… are now in the top 2% of net short positions held in the history of the series.” In other words, traders were almost as bearish as they could possibly get.

As any good contrarian investor knows, when everyone is betting on one outcome, chances are the opposite will happen. There are lots of sound reasons behind this.

If everyone is bearish, then there’s no one left to sell. That means you don’t need much in the way of good news to trigger a rally. Same goes for the other way around. If everyone is bullish, there’s no one left to buy.

But in the longer run, once the ‘oversold’ condition is shaken off, I can see sterling falling further. The fundamentals haven’t changed. If Osborne genuinely is relying on monetary policy to pull the economy out of a hole, then a weaker pound is a key plank of that strategy.

Central bankers don’t want a ‘disorderly’ sell-off in their currencies of course. The 17th century French politician Jean-Baptiste Colbert famously said that: “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.”

The art of inflating away debt – inflation is a stealth tax after all – is similar. You want a gentle drift lower, rather than a horrendous rout that hits the headlines and scares the horses. It’s all part of the government’s financial repression strategy.

So in short, keep making sure you diversify your portfolio beyond sterling. I made a few suggestions as to how here.

That said, I have to take my hat off to our spread betting expert John C Burford. In his free MoneyWeek Trader email on Wednesday, John took a look at the pound. He highlighted the fact that sentiment was so drastically against the UK currency, and argued the case for going long – it’s a bet that would have paid off. John also suggests a target for where the pound could bounce to. If trading currencies is something you’re interested in, you can sign up for his email here

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

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  • Jo

    Sorry but I don’t understand this comment from King “we are moving to a properly valued exchange rate. I think we’re probably there”.

    Does he mean that the true value is the now debased value, compared to 2007? Does he mean that the pound has a little way to fall and then “we’re probably there”?

    We should all know by now that everything that comes out of his/their mouth are lies anways and it is all rigged.

  • Dave

    King is heavy weight albeit a dead weight. He has completely mishandled the British Economy I really don’t know why anyone gives a two hoots to anything this discredited buffoon has to say on anything.

  • Nigel

    Simply because he gets to print the money!

  • Chester

    Diversifying out of Sterling is a sensible strategy, but currencies will rise and fall despite what Cenral Bankers / Chancellors think, do, or intend. The law of unintended consequences is more likely to shape the outcomes they may want

    The policy of financial repression in the UK has so far been supported by the markets, and specifically the rise of the US$. The $ is now due a correction, which will have a beneficial effect on the value of Sterling, irrespective of what Osbourne spouts on Wednesday

    If Central Bankers did control the value of currencies, no one would be buying US$ or Swiss Francs. Come the next wave of panic, both currencies will appreciate when markets buy them as the ultimate safe havens, irrespective of what the Feds do

  • alec

    The BoE and King in particular have no credibility left, in fact he Blair, Brown and Balls are the chief architects of the financial mess. You will recall that in 2004/5 when interest rates should have been increased, King decided to ingratiate himself to Greenspan at the Fed and reduced the bank rate. This set off the biggest financial bubble the country has ever seen. Then in 2008 King said he hadn’t seen the financial crisis coming when anyone with half a brain could see lending and borrowing were totally out of control. King should have been sacked before the end of his first term but then he ingratiated himself to Cameron and Osborne and said in hindsight he should have shouted from the rooftops about what the banks and building societies were up to, but not word from him! The consequences of this fellow’s incompetence are there for all to see.

  • Will

    The pound is oversold that is a fact. Look at the Australian dollar as an example; the exchange rate has dropped from 2.6 in 2008 down to 1.44 as of today. It now costs £8 for a big mac meal in Australia or £4 in the UK. Simples. The BOE has got what they wanted a devalualed currency but things have now got out of hand. Watch GBP rise in the next few months.

  • El tel

    I remember about 3 years ago King gave a speech in which he told us by 2013 growth would be whipping along at between 3 and 3.5 per cent. This was whilst simultaneously endorcing the coalitions austerity plan which was obviously going to crimp growth for a considerable amount of time. I remember wondering at the time if he was deluded, hallucinating, or just spinning a yarn. Thankfully Bill Bonner was on hand at MW to give us a more sober and realistic view of things. It is interesting as he now shuffles of to retirement he still hasn’t changed a bit.

  • Mick Finn

    @ Alec

    I believe you are correct in what you say. I remember 2004/2005. The economy was already overheating, debt levels were unsustainable, and there were red lights flashing all over the place. Interest rates should have gone up to about 7 / 8 per cent to head off a real calamity. But what did Meryvn King do, drop them fuelling as you say the biggest financial bubble this country has ever seen. All that was left after that point was to watch the full horror unfold. Most of the worst structural damage to the economy happened in the final two years of the credit boom. Unfortunately we are still living with the consequences of such folly .

  • Pete

    Why is everyone so negative about the weak pound? I thought all Western economies were in a ‘currency war’ to lower the value of their currency and give a boost to exports. Looking at Sterling it is fair to say that the UK won the war! Stay positive people!

  • Gordon Freeman

    Yes, sterling was overdue a bounce. And of course, don’t forget our old friends the commercials! They went massively long on the pound BEFORE the recent rebound, so how convenient that Merv came out and made those comments just now. You really can get by with a little help from your friends lol! And those same commercials are still long by the way (and increasingly short on the USD after its’ rally), so expect the sterling rally to continue (until the commies reduce their longs). That’s what it all seems to be about, trading the ups and downs to make a profit. I think the central bankers are just managing the currencies (along with gold etc.) within certain ranges to maintain the status quo. We’ll see how long they manage that 🙂

  • SteveH

    You wrote: If everyone is bearish, then there’s no one left to sell. If everyone is bullish, there’s no one left to buy.

    Would you like to try it again?