Monday, 14 October 2013

The British Pound Has Many Facets

Ralph Shell, Excel Analyst

Excel Markets Analysis Trading in the pound earlier this year often involved conjecture of the pending new plans for the stodgy Bank of England by their new hire, Mark Carney, the Central Bank superstar from Canada.  Among the world's highest paid central bankers, he would certainly feel obliged to earn his keep, impacting both the economy and the pound...

Carney was expected to increase the size of the BOE's assets, buying outstanding gilts, thereby increasing the supply of money.  The pound bears were delighted that such aggressive action would be taken once Carney got settled in, since this would weaken the currency.  This faulty theory helped take the GBPUSD down to 148.75 in early July.

Anticipating the lower pound, futures and option specs at the CME pressed the short side, and according to our COT Report from data of July 2nd, had amassed a short of over 46K contracts. The short position was wrong and so far the impact of Carney has been minimal.

According to

"If Mark Carney was going to live up to his billing as a "rock star central banker" – and his £874,000 a year pay package – he had to arrive in Threadneedle Street on a crashing crescendo. His first 100 days as Bank of England governor have been a noisy medley of speeches, impeccably tailored photo-calls and pzazz ... (and) ... the need for more women on banknotes."

As might be imagined, the bears got burned. 

The pound versus the USD rallied almost 1400 pips, to the topside of the 162.50 area.  On the rally, it was unusual to see the specs cling to their shorts, not flipping to the long side until the pound was trading above 1.58.

Part of the pound rally was the result of economic data that was consistently better than expectations.  Six months prior, the chief economist for the IMF, Olivier Blanchard, had a 'bleak' outlook for the British economy, and suggested they should abandon their austerity plans.

The IMF's forecast has been wrong. 

The increase in UK growth is going to be 1.4%, up from the forecast of 0.7% six months ago.  Part of the growth in the economy has been caused by the "Help to Buy" program.  In parts of the UK, especially London and the adjacent countryside, Kent, East and West Sussex and Surrey have become quite expensive.

Offering taxpayer subsidies for high loan-to-value mortgages does indeed bolster the housing market.  The Treasury had been hopeful, this plan would result in an increase in new construction but so far the biggest impact has been on existing property.  The IMF has warned this is a risky policy and will result in a boom-bust situation.

Acknowledging there may be a real estate bubble, there is now a Financial Policy Committee within the BOE.  Their job will be to prick the bubble before it gets too big.  Since Carney will be in charge of the committee, maybe this is why he earns the big bucks.

Another problem for Britain is the government size.  According to Matthew Lynn:

" has a state that is now way too large for the productive capacity of the economy. The state consumes 45% of GDP, but taxes raise less 36% of GDP — and no government in British history has ever managed to extract more than 38% of GDP in tax (the highest level, paradoxically, was the 37.6% the supposedly right-wing Lady Thatcher managed back in 1981). At some point, there will have to be massive cuts to state spending to close that gap."

Attempts are being made to cut the spending rate and control costs.  As members of the EU, they are obliged to accept many who want to immigrate there.  There is, however, a movement to slow the immigration, reduce the benefits once they are there, and eliminate free medical care.

A major problem for Britain is their costly EU membership. This membership gives Brussels the right to regulate and control much of the economy often without input or representation. 

For example, energy is expensive in England and most of Europe.  To stay cool in the summer and warm in the winter you are going to pay.  To alleviate this problem, Britain is beginning to drill for shale gas.  Some estimates claim the reserves on the island are enough for almost fifty years of energy needs.

Not so fast, says Jos Delbeke, the director-general of the European Commission's climate divisions.

"The level of methane emissions tilts the balance for or against the development of shale: it is the central issue. We don’t want to copy and paste what happened in the US. We will do things differently in Europe," he told the Daily Telegraph.

Mr Delbeke’s warnings come as Brussels draws up its framework law for shale by the end of the year, shaping rules that could make or break the industry in Europe. A tough code risks a cathartic showdown with Britain just as the country gears up for a referendum on EU membership. Any sense that Brussels was obstructing the UK’s economic revival could prove the last straw for many voters. "

There is a group called "Better Off Out" that is leading the charge for Britain to leave the EU.  If there is a cold winter, and correspondingly high heating costs, voters may not want to wait for PM Cameron's 2017 referendum about leaving the EU.

Click to Enlarge GBP/USD Daily Forex Chart

Where does that put the pound in the immediate term, say one to three weeks? 

First, you cannot ignore the USD is on the other end of so many pound positions. Open interest in the futures at the CME in the pound is larger than all contracts except the euro.

There was Friday optimism for a Washington settlement, but the weekend news was not as optimistic. Will that be the spark for a rally back toward the 1.61 handle?

If so, then my inclination is to be a seller. 

Click to Enlarge GBP/USD Forex Weekly Chart

We do have some British CPI numbers coming on Tuesday and some unemployment numbers on Wednesday.  The current unemployment number is 7.7% and expected to remain unchanged.  Carney has indicated 7% might be a number that would trigger some monetary changes, but that is not etched in stone. 

Perhaps between the Washington news and the economic numbers we will get a rally.  A downside target is the 1.5650 area.
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