Sterling safe from currency war

By:
Peter Garnham
Published on:

As Mervyn King, Bank of England governor, warns over currency wars, he can rest easy that sterling is not set to become a victim.

King recently expressed concern that we may now see “the growth of actively managed exchange rates as an alternative to the use of domestic monetary policy”.

So far, however, sterling strength shows no sign of undermining the Bank of England’s attempts to revive the UK economy.

Since the turn of the year, sterling is down 2.5% on a trade-weighted basis. Indeed, the only two G10 currencies that have underperformed the pound are the yen and the Swiss franc, both of which are being actively weakened by policymakers seeking to use their currencies as a tool to invigorate their economies.

In sterling’s case however, the market is doing the authorities’ work for them, pushing it below $1.60 to a two-month low against the dollar and sending it down to a

10-month trough against the euro.

Sterling has been assaulted from all sides, not least of which has been the drying up of haven demand for UK assets now that worries over the eurozone debt crisis appear to be receding.

Indeed, Simon Derrick, head of FX strategy at Bank of New Mellon, says in the recent past judging the outlook for sterling has been a relatively straightforward affair.

“While in the past we would have largely focused on the importance of yield differentials in driving the performance of sterling, in the post 2010 world, the key issue has been investors seeking a safe haven away from the eurozone crisis,” he says.

“However, with the existential threat to the eurozone now subsiding, we must admit to growing concerns about the outlook for the pound.”

Those worries include the prospect that the UK would lose its triple-A debt rating and the faltering health of the British economy – both subjects that have been overlooked by currency investors as the eurozone debt crisis rumbled on.

Indeed, as Derrick points out, while the eurozone debt crisis might be easing, there are few signs of recovery in Europe, the UK’s major trading partner. That, he says, is a fact reflected in Britain’s poor trade data.

If renewed worries over the UK’s credit rating and economy were not enough, another factor also bodes ill for sterling: the prospect of Britain renegotiating part of its relations with the EU.

Admittedly, change is a distant prospect – any alterations look set to be put before UK voters in a referendum after the next general election, providing of course that the Conservative Party remains in government.

For UK-based investors, the topic is well understood, but for international investors, the UK’s relationship with its EU partners is less well known, and only now, it seems, attracting their attention.

Paul Robson, FX strategist at Royal Bank of Scotland, says the prospects of the current UK government retaining power will become increasingly important in pricing sterling in the longer term, while the realization that there is potential for a change in UK/EU relations is likely to hit near-term sentiment.

“Uncertainty over the long-term outlook – for trade and FDI most noticeably – may play GBP negative over the coming weeks,” he says.

The pound is certainly suffering, and with interest rates at ultra-low levels and unlikely to rise anytime soon, it could well transform into a funding currency for carry trades. That would be quite a switch for a currency that just a few months ago was benefiting from haven demand.

One thing seems more certain: for now the Bank of England should have no need to engage in currency wars.