Weighed down by the UK’s increasingly bleak economic outlook, sterling felt the full impact of the dollar’s resurgence in August.
There was no nice summer holiday for the UK’s currency in August. The pound found itself under extreme pressure and a combination of factors combined to send it sharply lower, especially against a resurgent US dollar. The exchange rate plunged from just a shade below $2 to the pound to a little above $1.80, its largest monthly fall since the distant days when sterling was pulled unceremoniously from the old European Exchange Rate Mechanism on September 16 1992.
There are both similarities and differences between the events of 16 years ago and those of today. Although the 1992 adjustment was dubbed Black Wednesday at the time – most probably as a result of a sense of losing national pride – many have since argued that sterling’s rapid decline enabled the UK to regain an economic competitive edge. Whether that will prove the case this time around is highly debatable.
Some commentators have claimed that the 1992 devaluation finally destroyed what was left of the then ruling Conservative party’s reputation, especially with regards to its steering of the UK economy. Many are now saying that history has repeated itself, especially after comments from UK chancellor of the exchequer Alistair Darling in a newspaper interview that seemingly put him at odds with his Labour government colleagues. Darling’s remarks were the catalyst that sent cable below 1.80 and the euro/sterling rate to an all-time high of 0.8139. The chancellor had claimed in a supposedly frank but almost certainly ill-advised assessment of the UK economy that the country was going through its worst economic adjustment for 60 years. Time will perhaps tell why he was so forthright. But coming the weekend before the regular meeting of the Bank of England’s monetary policy committee, some cynics naturally suggested that they were designed to try to force the central bank into making a rate cut.
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"Our long-term view remains – we will eventually see 1.60 for cable and parity for EUR/GBP"
Paul Day, Mig Investments |
Before the collapse of Lehman Brothers, few saw little chance of sterling staging anything other than a temporary bounce. "Cable has been the stand-out underperformer against the dollar and we think that’s likely to remain the case," says Ian Stannard, senior currency strategist at BNP Paribas. "We have been one of the most bearish houses but we’re now going through the process of looking at our forecasts and we’re probably going to move our targets even lower. We think we’re likely to see 1.7000 for cable by the end of the year.
"The economic outlook appears to be getting worse and the chancellor’s recent comments suggest that there’s a lot more going on behind the scenes than we realized. There doesn’t appear a lot of room for manoeuvre. The government’s hands are largely tied in terms of fiscal measures, while it looks like inflation is still heading higher. There’s little room for the Bank of England to act but we do think it will cut rates before the year-end. All of these factors are putting a lot of pressure on the pound."
Paul Day, deputy head of research at Mig Investments, expresses a similar view. "Sterling’s performance is starting to look very worrying against all major currencies as it continues to play out our view that it will be the dog of the FX markets during 2008," he says. "Our long-term view remains – we will eventually see 1.60 for cable and parity for EUR/GBP. The UK has all the problems the US has faced but with a nine-month time lag," he says.
He adds: "We can see the situation starting to develop where it is no longer supported by carry trades. Our EUR/GBP view is probably more extreme than most houses, and to a degree it depends as much on where EUR/USD goes. We don’t think that the dollar is yet in a position to sustain its current broad-based recovery," Day adds.
Stannard is not so sure that sterling will fall to parity against the euro, a level that would put it below 2.00 in old sterling/Deutschemark terms. "Sterling is also weak against the euro. EUR/GBP has made new highs and we think the move will extend to 0.8200 or 0.8300. However, we are suggesting some caution, because it’s starting to get ugly in the eurozone as well," he cautions.