The economic recovery – Return of the pound?

20140502-185855.jpg

The economic outlook of the UK has had an impact on the Foreign Exchange markets. The pound sterling is strengthening against many currencies in both the developed and emerging markets however in this blog I’m going to focus on the relationship between the pound and the dollar and the positives/negative impacts as a result of this. First of all what does it mean for the pound to strengthen against the dollar? Basically you get more dollars for every pound when you go to exchange it at your local bureau. What has caused this in the markets? Well it is a combination of the following – the outlook on monetary policy and economic recovery.

Monetary policy in a nutshell is the setting of interest rates. The Bank of England Base Rate has been set at a record low 0.5% for 5 years now primarily down to the recession that had plagued the country for years. This was to enable businesses (and banks) to borrow from banks to fund operations and create new employment opportunities to compensate for all the jobs lost during the difficult period post 2008. In 2009 GBPUSD was trading at 1.3505, a 23 year low! The Bank of England announced earlier this year that they expect the Base Rate to increase by 2nd Quarter 2015. Due to the positive correlation between interest rates and foreign exchange rates, this led to the pound strengthening against major FX currencies and emerging market currencies. In fact $11bn was removed from emerging market funds by the end of February primarily down to the positive outlook investors had on developed markets (source:Bloomberg)

The economic recovery has also played a part in strengthening the pound. UK unemployment fell by 63,000 to 2.33 million in the three months to January 2014, according to the Office of National Statistics. Lower unemployment will inevitably lead to an increase in a country’s GDP which symbolises growth and is one of the many signs of recovery. The budget especially the reforms relating to ISA’s and pensions were seen by the public as great news (more details check here)

The strengthening of the pound great news for people like me who want to get as many dollars as possible to use to spray at Nigerian weddings this summer but is bad for British investors in UK blue chip companies, as many of these firms report their profits and deliver dividend payouts in dollars. Capita Asset Services released a report recently arguing that the pound’s strength will wipe £3.5bn off the value of dollar denominated dividends of UK based firms.

With the weaker than expected US first quarter GDP growth (0.1% Actual v 1.1% Expected) and the manufacturing sector purchasing managers’ index reaching five-year highs this week,this will provide the impetus for investors to capitalise and invest in the Pound, before it’s too late and there is a ‘correction’ in the market.

GBPUSD is currently trading around 1.68-1.69 (i.e. 1 Pound = 1.6878 Dollars) – which is a 5 year high for the currency pair. Who knows the days where you’d get a 2 dollars for every pound may soon be back on the horizon – only time will tell….
@capitalmoments

Advertisements

4 comments

  1. As an economist I feel that’s it’s tremendously important to mention the importance of expectations in the setting on monetary policy.

    “Monetary policy in a nutshell is the setting of interest rates.” That would be true in normal economic circumstances, but we must bear in mind that have been in a liquidity trap (i.e. near zero interest rates) for around 6 years now.

    For the past few years, monetary policy has been about the setting of expectations and, more importantly, the market’s belief in those expectations. Indeed, markets are looking favourably on the UK from a rates/fx perspective because they believe that the bank of England will be the the first of the major central banks to engage in a rate hike.

    “Who knows the days where you’d get a 2 dollars for every pound may soon be back on the horizon – only time will tell….” Perhaps Mrs. Yellen at the Fed may like that, an undervalued dollar could improve competitiveness of USD and improve the economy via a financial trading channel….

    1. Thank you for your comment I appreciate your feedback. Yes I agree with you in recent years monetary policy has been used more to set expectations but going into that would be another whole blog completely! I would love to pick our brains on your second point with regards to why Yellen would prefer an undervalued Dollar – could you please explain if you have time? Thank you.

      1. I think that Monetary policy hasn’t been used ‘more’ to set expectations, it’s only been about the setting of expectations; otherwise we would have seen a change in rates over the last few years.

        As for Yellen, it really depends on where she believes the US recovery should come from. If done via the external channel (imports & exports), a weak dollar means that channel is more favourable to people outside the US. You’d prefer to head stateside if you could get $2 for £1 as opposed $1 for £1, right?

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s