October Currency update

A month ago we were bleating about August having been a rubbish month for the pound.  At the end of September nothing has changed except the date.  Sterling shed three and a half euro cents in August and has cut another three and a half in September.  At one point it was as low as €1.0750 and more than one analysts was looking ahead to parity with the euro.  Goldman Sachs stood aloof from most other firms with a recommendation that clients buy the pound but that was more than a week ago: since then Goldmans have been keeping a low profile on the subject.

In August the blame for sterling's decline appeared to lie with the growing budget deficit - the gap between public spending and tax revenues - and the Bank of England.  Here again the situation is unchanged.  The prime minister has conceded that spending cuts will be necessary but more important to him than that is the election that he will have to fight in no more than nine months' time.  The market doubts he will have the will, let alone the parliamentary support, to raise taxes and cut spending, especially at this early stage in the recovery.

The Bank of England's impact - let's not call it interference - remains as great as ever.  Ahead of the Monetary Policy Committee meeting early in the month investors were steeling themselves for another bouncer.  There was therefore a degree of relief when the MPC left interest rates unchanged and did not expand the scale of the Bank's quantitative easing ("printing money", except that it's not) programme.  The market refused to be lulled into a false sense of security, however, and remained on its guard.  That was just as well, for little more than a week later the governor told parliament's Treasury Select Committee that he had considered lowering the discount rate, the rate paid on commercial bank's reserves, to below zero.  By doing so, he mused, banks would be more likely to put their cash to good use instead of hoarding it.  It was not an outrageous suggestion; Sweden's central bank has been doing exactly that since July.  But the market heard the phrase "rate cut" and did a runner.  Less than a fortnight later the governor was in to bat again.  He told the Newcastle Journal that the decline in sterling's value "will be helpful" in rebalancing Britain's economy.  You didn't need to be an economist to figure out the enormity of that one. 

The suspicion has been growing among investors that the Bank of England is deliberately talking down sterling as a sort of policy-easing-by-devaluation.  A weakening pound loosens monetary policy in a similar way to low interest rates and quantitative easing.  It keeps inflation higher than it might otherwise be because imports become more expensive.  For the economy of course it is potentially good news, as we discovered after the Exchange Rate Mechanism expedition in the early nineties.  Not only do British-made goods and services exports become more competitive (or more profitable), British consumers also become more inclined to substitute domestically-produced goods for things they would previously have bought from abroad.  That is what the governor probably meant:  What the market heard was "I want sterling to go lower".

Following a meeting at the end of the month, held by the Bank of England to clear the air, investors have become slightly less hostile to sterling.  That is not to say they once again.  Even without the verbal intervention of the Bank of England (assuming it has learnt its lesson) there are still the same political and budgetary worries.  Investors will not flock back as long as the widening deficit shown no sign of halting.  Having regained three euro cents from its low the pound probably has a couple more up its sleeve but, after that, it is hard to see how the current situation will allow it to stage a meaningful recovery.

 
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