Pity Poor Pound

October 14, 2009

Britain’s pound has long been the whipping boy of notoriously fickle currency markets, but there are worrying signs that it’s not just hedge funds and speculators who have lost faith in sterling. Reuters FX columnist Neal Kimberley neatly illustrated yesterday just how poor sentiment toward sterling in the dealing rooms has become and the graphic below (on the sharp buildup of speculative ‘short’ positsions seen in U.S. Commodity Futures Trading Commission data) shows how deeply that negative view has become entrenched.              

 While the pound’s inexorable grind down to parity with the euro captures the popular headlines, the Bank of England’s index of sterling against a trade-weighted basket of world currencies shows that weakness is pervasive. The index has lost more than a quarter of its value in little over two years — by far the worst of the G4 (dollar, euro, sterling and yen) currencies over the financial crisis. The dollar’s equivalent index has shed only about a third of the pound’s losses since mid-2007, while the euro’s has jumped about 10% and the yen’s approximately 20% over that period.

There’s no shortage of negatives — Britain’s deep recession, recent housing bust, near zero interest rates and money printing, soaring government budget deficit (forecast at more than 12% pf GDP next year, it’s the highest of the G20) and looming general election in early 2010. In the relative world of currency traders, not all of these are necessarily bad for the pound — the country is emerging tentatively from recession, the dominant financial services sector is recovering rapidly and  short-term interest rates (3-month Libor at least) do offer better returns than the dollar, yen, Swiss franc or Canadian dollar. 

But recent data from the IMF on global hard currency reserves shows there may be a more disturbing exit of central bank reserve managers from the pound (no stranger to process of losing reserve currency status, as its pole position was ceded to the dollar after WWI).  Sterling’s share of the almost $7 trln of world central bank reserves — which are rising sharply again after a brief hiatus due to the credit crunch — is being steadily eroded. 

Although nominal reserve holdings of sterling (the rise of which prior to the crisis was seen as a powerful supporter of both the currency and gilt market) did rise by more than $10 bln in the second quarter, they remain about $24 billion below the peaks of Q2 2008. What’s more, Citi economist Michael Saunders estimates that once you adjust for revaluation effects of currency rate swings, central bank holdings of sterling actually fell in Q2 this year.  He reckons that, accounting for these adjustments, Q2 was the second consecutive quarter of net sterling sales by central banks and that the 4 billion pound drop in nominal sterling holdings was the biggest on record. Saunders concludes:

The huge inflows of global FX reserves into sterling and gilts have played a big role in financing the fiscal deficit in recent years. At present, the fiscal deficit is being wholly funded by the BoE, but sterling remains vulnerable and gilts seem highly vulnerable as and when QE ends.

(Graphs by Scott Barber and IMF/Citi)

4 comments

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Sterling up 1.5% today LOL

Posted by Gerry Kavanagh | Report as abusive

good reverse indicator! I guess when the last bull turns bearish is the right time to buy :)) One postscript to the blog though is that if central banks were for some reason to rethink this sterling divestment and the trend to adopt SDR-style reserve baskets actually takes hold –then sterling currently holds a weighting of 11% in the SDR but only has little over 4% of world reserves. That would mean a lot of catchup (and for the yen too for that matter) So, may be this is indeed the nadir — sadly we have to wait until Dec 31 for the next comprehensive IMF reserve breakdown for Q3.

Posted by Mike Dolan | Report as abusive

Very interesting news and data about the pound. I think this is consistent with the general trend of most fiat currencies, that the global economic problems and money printing efforts are leading to a lack of faith in all currencies. And I think this is being reflected in the gold price reaching new all-time highs. I recently read some good articles at http://www.goldalert.com that discuss central banks’ easy monetary policies in order to try to prevent any sort of deflation from occurring. One I found particularly insightful is called “Gold Price Up, Dollar Down – Does it Really Matter?” I think these articles are very useful for any investor because they help to explain the investment implications for the fiat currencies, the gold price, and gold mining companies who I think should continue to benefit from central banks’ inflationary programs.

Posted by mthomas | Report as abusive

I don’t know why people get so worked up about this. The drop in sterling is doing exactly what it should do – relieving stresses in other parts of the system. Thank God we’re not in the euro. They’ve gone quiet for the moment, but believe me the French and others will soon be screaming again about the strength of the euro against the pound and even more so against the dollar. The one-size-fits-all suit now has a 54 inch chest and keeps growing, and most of the eurozone is looking pretty bloody daft in it.

Posted by Matthew | Report as abusive