The Future of the Pound
A Fleet Street Letter Special Report
Published 17th December 2008
The pound is in peril.
The UK is braced for the worst recession in living memory. Production will fall and fall hard. Even the most optimistic analysts believe the UK economy will contract for at least another 12 months.
However, fears over the economy are not the only problem for our currency.
As the credit crunch sets in, the dynamics of the currency markets are changing. As many investment firms are going under, the number of players in the market making transactions has fallen sharply. And this has a drastic effect on how trades are conducted.
Let me demonstrate with a theoretical example. Assume an investor is anticipating the euro to fall against the dollar:
In 2007 (pre-credit crunch) the offer on the market is 1.5 dollars to one euro. There are 100 market operators offering rates for the investor to sell their position every second during the lifetime of their trade. The euro falls 1.50, 1.499, 1.498… This smooth price transition is the presence of liquidity.
In other words, it is impossible to carefully manage risk with such jerky movements and so traders are bailing out of risky trades.
And this liquidity drought, should it continue, could see sterling become effectively a “small cap” currency. Just as thinly traded small cap shares can see sudden rises and falls in price on very few orders, so the same thing is happening with the pound.
The Flight to Safety
With fewer participants in the market, those that are left are playing it safe.
This means fleeing to more liquid “safe haven” currencies. As investors continue to sell more risky currencies – those currencies prone to higher volatility – they are buying the most liquid and heavily traded currencies.
In 2008, that meant investors headed out of the pound and into the “large cap” currencies like the US dollar. As you can see below, all this selling is bad news for the value of the pound.
Source: Barclays Wealth
Our currency is illiquid, our economy is in recession, and our interest rate – the one potential lure of the pound – has shrunk to 52 year lows. As the recession takes hold in 2009 and more banks fold, our currency could be hit even harder.
Yes, we all thought inflation – the rise in the price of goods and services – was gone, but a weak pound is breaking inflation’s fall. The latest official measure of CPI inflation – the value of the goods in your average shopping basket – fell by only 0.7% to 4.1%. The City was expecting a more palatable fall to 3.8%.
The City consensus expects lower inflation and therefore lower prices to come 2009. However, if the pound falls much further, then this is going to affect our spending power and our price stability in the year ahead.
This would make us all poorer.
This is why it is so important to hedge when investing. Specifically, it is extremely important to hedge against the downfall of the British economy.
The pound is effectively becoming a small cap. It is a risky currency that can be pushed around by a market that is gloomy on the UK’s prospects.
It is not impossible that our liquidity crisis could hit the murky depths of that other well-publicised small cap currency, the Icelandic krona. Iceland’s banking and liquidity crisis pushed the krona down 45%. The UK is down 24% and counting. For investors, now might be a good time to bet against the pound.
Best wishes,
Theo Casey,
For Fleet Street Invest
P.S. If you enjoyed this article then you will like The Fleet Street Letter. In it we present the ONE investment you should make immediately to protect yourself from a sterling crisis. To find out more, click here.
Published 17th December 2008
The pound is in peril.
The UK is braced for the worst recession in living memory. Production will fall and fall hard. Even the most optimistic analysts believe the UK economy will contract for at least another 12 months.
However, fears over the economy are not the only problem for our currency.
As the credit crunch sets in, the dynamics of the currency markets are changing. As many investment firms are going under, the number of players in the market making transactions has fallen sharply. And this has a drastic effect on how trades are conducted.
Let me demonstrate with a theoretical example. Assume an investor is anticipating the euro to fall against the dollar:
In 2007 (pre-credit crunch) the offer on the market is 1.5 dollars to one euro. There are 100 market operators offering rates for the investor to sell their position every second during the lifetime of their trade. The euro falls 1.50, 1.499, 1.498… This smooth price transition is the presence of liquidity.
The Future of the Pound : Less Market Operators, More Risk
But now in 2008 (mid-credit crunch) the same investment looks very different. With only 10 market operators where previously there were 100, the progression of that trade becomes much more jerky. The euro falls 1.50, 1.45, 1.40… In currency terms, these are massive jumps as investors and traders may have millions riding on every decimal point the currency ticks along.In other words, it is impossible to carefully manage risk with such jerky movements and so traders are bailing out of risky trades.
And this liquidity drought, should it continue, could see sterling become effectively a “small cap” currency. Just as thinly traded small cap shares can see sudden rises and falls in price on very few orders, so the same thing is happening with the pound.
The Flight to Safety
With fewer participants in the market, those that are left are playing it safe.
This means fleeing to more liquid “safe haven” currencies. As investors continue to sell more risky currencies – those currencies prone to higher volatility – they are buying the most liquid and heavily traded currencies.
In 2008, that meant investors headed out of the pound and into the “large cap” currencies like the US dollar. As you can see below, all this selling is bad news for the value of the pound.
Pounded – Sterling falls hard against large cap, the US Dollar
Source: Barclays Wealth
Our currency is illiquid, our economy is in recession, and our interest rate – the one potential lure of the pound – has shrunk to 52 year lows. As the recession takes hold in 2009 and more banks fold, our currency could be hit even harder.
The Future of the Pound : What does a weak pound mean for UK investors?
Inflation.Yes, we all thought inflation – the rise in the price of goods and services – was gone, but a weak pound is breaking inflation’s fall. The latest official measure of CPI inflation – the value of the goods in your average shopping basket – fell by only 0.7% to 4.1%. The City was expecting a more palatable fall to 3.8%.
The City consensus expects lower inflation and therefore lower prices to come 2009. However, if the pound falls much further, then this is going to affect our spending power and our price stability in the year ahead.
This would make us all poorer.
This is why it is so important to hedge when investing. Specifically, it is extremely important to hedge against the downfall of the British economy.
The pound is effectively becoming a small cap. It is a risky currency that can be pushed around by a market that is gloomy on the UK’s prospects.
It is not impossible that our liquidity crisis could hit the murky depths of that other well-publicised small cap currency, the Icelandic krona. Iceland’s banking and liquidity crisis pushed the krona down 45%. The UK is down 24% and counting. For investors, now might be a good time to bet against the pound.
Best wishes,
Theo Casey,
For Fleet Street Invest
P.S. If you enjoyed this article then you will like The Fleet Street Letter. In it we present the ONE investment you should make immediately to protect yourself from a sterling crisis. To find out more, click here.
Your capital is at risk when you invest in shares – you can lose you some or all of your money, so never risk more than you can afford to lose. Figures may refer to the past or be forecasts. Past performance and forecasts are not reliable indicators of future results. The FSA does not regulate certain activities, including the buying and selling of commodities such as gold. If in doubt about the suitability or taxation implications of any investment, seek independent financial advice.
Related articles on The Future of the Pound:
What To Do Before The Pound Falls Further
-
There are a number of ways to hedge. Gold, perhaps. Or assets denominated in another currency...
I think the euro looks attractive. It is coming of age as a truly global currency. The European Central Bank has taken a firmer line on inflation than either the US Fed or the Bank of England. And the economic size of the eurozone means, in time, the euro could trump the ailing dollar as the world’s reserve currency — something the pound will never be again.
The Other Main Story in Tomorrow’s Newspapers
-
It’s little wonder, then, that the pound has once again become the whipping boy of the currency markets. Since the start of the week, sterling has fallen from $1.49 to $1.39, a slump of 6.7%. It’s reached the lowest level for seven years against the dollar. Against the mighty Japanese yen, it’s hit a new all-time low of 125.25 and against the euro, sterling fell by it’s biggest daily move in the past month.
Should Britain Join The Euro? No, No, No!
-
Why should we oppose joining the single currency? There are economic, political and practical grounds to steer clear. Even Justice Minister Jack Straw himself has conceded that the euro is not a "piece of magic for the economy."
External links on The Future of the Pound:
Pound's slide can bring in the pennies
-
Clients of private banks have been moving their money into non-sterling denominated accounts. Cater Allen Private Bank said recently that increasing numbers of clients had been shifting from sterling accounts into euros.
Sterling slides, pressured by BoE rate cut expectations
-
Also putting sterling under selling pressure was a slide in UK shares, reflecting the parlous state of the British economy.