Pound’s Demise Will not be Hard to Time

I’d like to follow up on my last post (Timing is Everything in Forex, Especially in this Environment) by looking at how to time one specific currency: the Pound. As I noted tongue-in-cheek with the title of this post, timing the Pound will not be difficult, since it is likely headed downward in both the short term and long term.

In the short-term, the Pound will be crippled by the UK’s economic woes: “Britain is the last of the big G20 countries still to be mired in recession. Its GDP has shrunk by 4.75% this year, far more than the 3.5% reckoned likely in April.” There’s no reason to pore through the economic indicators, since all signs suggest that it won’t be until 2010 that Britain returns to positive growth.
Of primary concern to forex markets, however, is not economic growth (or lack thereof, in this case), but rather how this will effect the decision-making of the Bank of England (BOE). To no surprise, the BOE announced yesterday that it would maintain its benchmark interest rate at .5%, and its liquidity program at current levels. It didn’t give any indication, meanwhile, that monetary policy on either of these fronts would change anytime soon.
Thus, Britain could conceivably replace the Dollar as one of the preferred funding currencies for the carry trade. While the Fed is also in no hurry to hike rates, the US economy has already emerged from the recession, which means that regardless of when it tightens, it will almost certainly be before the Bank of England. Unless the BOE pulls an audible then, timing the Pound will be fairly straightforward; the currency should begin to slip as soon as its peers begin to raise rates. Some analysts expect that the Pound will decline to $1.50 per Dollar within the next six months.

Over the long-term, the narrative governing the Pound is naturally more uncertain, but still straightforward. To try to dig itself out of recession, the government has spent itself well into the red, to the extent that this year’s budget deficit is forecast to be a whopping 12.6%, Next year could be even worse. The government has implemented a couple of half-baked measures designed to curb the deficit, but most of these are aimed at increasing tax revenue (which is futile during a recession), rather than trimming spending. While ratings on its sovereign debt were recently affirmed at AAA, Moody’s has warned that a downgrade in the next few years is not inconceivable.
So there you have it. As far as I’m concerned, the only question of timing, vis-a-vis the British Pound, is when the decline will begin. My guess is sometime in the beginning of 2010, when investors start getting serious about projecting near-term interest rate differentials, and pricing them into exchange rates. While most forex traders aren’t thinking this far down the road, it’s also comforting (for bears, not bulls, obviously) that the long-term fundamentals point to a sustained decline in the Pound. Whereas the Dollar could jump up before heading back down – making timing a crucial skill – the Pound will probably just head down.