September currency update

As months go, August was a fairly rubbish one for the pound.  It began well enough, with sterling apparently heading for another look at the June highs near €1.19.  In the event it never got much beyond €1.18.  After a week of fruitless effort investors decided enough was enough and cashed in their chips.  Over the following three weeks the pound marched resolutely backwards, touching a low of €1.13 before the end of the month and never making any real effort at recovery.

There were two reasons for sterling's fall from grace; the Bank of England and the economic data.  The Bank's crime was to up the ante with its Asset Purchase Facility, the scheme through which it has been buying up government bonds in order to increase the supply of money.  At its August meeting the Monetary Policy Committee decided to add another £50 billion to the £125 billion it had already spent.  The market had not been prepared for such a move; most investors had thought the economy was doing well enough not to need increased stimulus.  They were therefore unnerved by the Bank's pessimism.  For them to read in the Bank's statement that the recession is "deeper than previously thought" was a bit of a shock.

Sterling got another smack in the teeth two weeks later from the Bank of England's Quarterly Inflation Report and from the Governor's introductory comments.  Lest anyone be unduly optimistic, Dr King opened up with the warning that "The world economy remains in a deep recession and its financial system in a fragile condition."  As for the British economy, recovery could be "slow and protracted".  The sentiment festered in investors' minds.  A third blow from the Bank came in the minutes of the August meeting.  It transpired that not only had the committee put an extra £50 billion in the kitty to "print money", the governor himself had been outvoted in a bid to stick in an extra £25 billion.

As if to reinforce the Bank's gloomy message, the UK economy started to deliver statistical evidence of its problems.  What particularly upset the applecart was the public sector net borrowing  figure for July.  July is normally a good month for the Treasury, with tax receipts exceeding public spending.  Expectations were lower than usual because of the recession, but investors were not ready for the £8 billion jump in public sector net borrowing that suddenly confronted them.  Everyone knows that the government is planning to borrow in the next few months as much as previous governments have borrowed in total, ever.  Even so, this reminder was an unwelcome one and sterling felt the pressure.

The euro had a relatively easy run, with no shocks either from the European Central Bank or the data.  Figures for the Euro zone economy in the second quarter of the year were actively helpful.  Euroland's economy as a whole shrank by just -0.1%.  It was a far better performance than Britain's (revised) -0.7% shrinkage.  France and Germany both managed to expand their economies by +0.3% in Q2, making the UK's achievement look even more pitiful.

A month ago the outlook for sterling was reasonably positive.  At the beginning of September that is no longer the case.  Whilst it could fairly claim to have been hard done-by in August it will need to put in some better economic data before recovery can be expected.

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