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Sterling has continued its sell-off this week. As things stand the GBPUSD is on course to make a fresh 31-year low. Back in February 1985 the GBPUSD briefly traded below 1.0500. As can be seen from the chart below (courtesy of fxtop.com) that was a precipitous fall from where it stood at the beginning of 1981 – just above 2.4000. As sterling hit its low-point the miners’ strike was drawing to an end. However, the decline in cable back then was as much about the turnaround in the US economy as a downturn in the UK’s. Paul Volker had assumed chairmanship of the US Federal Reserve in the summer of 1979 with a mission to bring inflation under control. And he is widely credited with this success, taking inflation from 14.8% in March 1980 to 3% in 1983. However, he wasn’t universally popular as he took the Fed Funds rate up from around 11% in 1979 to 20% by the summer of 1981.

How different things are today.

PM Bulletin

Sterling continues to come under pressure as investors fret about uncertainty ahead of negotiations to leave the European Union. This was brought into sharp relief at the Tory Party conference when Prime Minister Theresa May fired the starting pistol for the withdrawal process. Investors are concerned that the government's stance points to a "hard Brexit.” This could see the UK take back control over migration but as a consequence lose access to the single market. There is a fear that this will lead to an exodus of banks and other financial institutions from the UK, and London in particular. This would lead to falling tax receipts and a further widening of the budget deficit. However, none of this should come as a surprise to anyone following the debate over the UK leaving the EU. The Brexit result is all about sovereignty. What is still unclear is if the UK can regain sovereignty, extract itself from the customs union and negotiate a favourable trade deal. This maybe uncertain, yet nothing has happened to suggest it can’t happen.

So there are other things weighing on the currency. As in the early eighties dollar strength is partly to blame. Bear in mind the US Federal Reserve is threatening to hike rates before the year-end while the Bank of England said it could loosen monetary policy further. In addition, Chancellor Philip Hammond looks set to use Brexit as an excuse to boost infrastructure spending, abandoning his predecessor George Osborne’s plan to eliminiate the country’s persistent budget deficit by 2020.

So for the time being sterling is out of favour with investors. But bear in mind that the latest World Price Index (WPI) data for October shows that at 1.2700 (and we’re currently even lower at around 1.2250) sterling is 13% undervalued against the dollar in purchasing power parity (PPP) terms. Now currencies can stay cheap (or get cheaper) relative to others for long periods at a time. But at some stage investors are going to wonder if the market has got out of whack. It may not be for a while, but sterling has yet to go down for ever.

David: Bear in mind the US Federal Reserve is threatening to hike rates before the year-end while the Bank of England said it could loosen monetary policy further.

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Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin PM

Category: PM Bulletin


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