Pound Set for Pain as Cuts Push King to Print Money
Comment of the Day

October 25 2010

Commentary by Eoin Treacy

Pound Set for Pain as Cuts Push King to Print Money

This article by Lukanyo Mnyanda and Stephen Morris for Bloomberg may be of interest to subscribers. Here is a section:
"The U.K.'s fiscal policy is going to be tighter than anyone else's, and therefore there's much less reason to expect any tightening of monetary policy even if there is some sort of global recovery," said Adrian Schmidt, London-based foreign- exchange strategist at Lloyds Banking Group Plc in London.

Schmidt said the pound may weaken to 95 pence per euro this year.

"The ECB will be raising rates before the BOE," he said.

Since raising their fourth-quarter predictions for the pound to as strong as 80 pence per euro in July, a level not seen since November 2008, analysts now see the currency trading at 86 pence by year-end, according to the median forecast in a Bloomberg survey. In the past year, the median fourth-quarter estimate for sterling versus the dollar has fallen more than all but four of 60 pairs tracked by Bloomberg.

Fitch Ratings said Oct. 20 the budget cuts were consistent with the U.K.'s top AAA credit rating. With the inflation rate above the government's 3 percent upper limit since March, bulls say the Bank of England may avoid more quantitative easing.

Eoin Treacy's view Sentiment towards the Euro/Pound exchange rate has vacillated widely over the last couple of years. At the World Money Show in London last November, sentiment towards the Pound was apocalyptic with a number of people I shared a panel with predicting the imminent demise of the currency. I felt like the lone person talking about a rally for the Pound; pointing out that foreign exchange is always a story of two halves and Europe has its own problems. I had no idea at the time that the peripheral European sovereign debt crisis was about to move centre stage but the chart action suggested that the Euro was under distribution from January 2009.

I have been invited to sit on another panel at this year's World Money Show in London, this time on the subject of "Trends that will dominate the markets in the next 10 years and how to profit from them". The discussion will take place on Saturday the 13th at 2:15pm.

Right now, the focus of attention has swung back to question the integrity of the Pound given the assumption that the Bank of England will resume printing in order to support the economy. The last monetary policy committee was split on the need for such actions as domestic deflationary pressures are weighed against persistently above target inflationary pressures. The necessary fiscal consolidation that the Conservative led coalition is introducing will help to support the Pound over the medium-term by closing the budget deficit. In the short-term however, this has contributed to a headwind for the currency, particularly since the ECB has been less than enthusiastic about quantitative easing.

Hawks at the ECB are currently seeking to remove emergency liquidity measures, implemented to avoid the disintegration of the group's financial system. The ECB has to weigh surging export growth, particularly in Germany, against the ongoing fiscal consolidation in a number of peripheral countries. Part of the agreement between peripheral countries and the Eurozone core was that access to liquidity would be assured for countries that agreed to make the necessary sacrifices to close budget deficits. The financial systems of Ireland and Greece in particular would collapse without recourse to such credit so while German economists might be unsettled with the length of time such liquidity measures have been in place, it is difficult to see how they can be removed without initiating another peripheral debt crisis.

The Euro found support, mostly in the region of 82p, from June and has rallied impressively since early September, to push back above the 200-day MA. It consolidated in the region of 88p, broke upwards last week and is now testing the almost two-year progression of lower rally highs, currently near 92.5p. Following an already impressive advance, I am wary of becoming overly bullish of the Euro within such close proximity of a potential area of medium-term resistance. However, despite this caveat, the short-term uptrend remains relatively consistency and a sustained move below 87p would be required to check momentum beyond a brief pause.

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