How the Pound Got So Bloody Heavy

Just recently, I presented several good reasons why things could get ugly for the pound. And guess what? The pound has gotten beat up pretty badly lately, with both the Cable and Guppy plummeting by more than a thousand pips in just a couple of weeks!

Chalk it up to poor fundamentals or the possibility of further easing, but one thing’s for sure: The pound has been clobbered so bad lately that it has been unable to get back on its feet and put up a fight against the greenback and the yen. In fact, both the Cable and the Guppy are undergoing such strong downtrends that they seem to be aiming for their yearly lows!

After reviewing some of the latest economic reports from the UK, I realized that their economy isn’t in such a terrible shape after all… At least, on the surface. Their fourth quarter GDP saw an upward revision from 0.1% to 0.3% while manufacturing conditions remained stable. Still, pound pairs were unable to take advantage of the recent run of good news. What gives?

I read up on Pip Diddy’s daily economic roundup today and noted some interesting ideas. First, British company Prudential, an insurance firm, announced that they would be buying up American International Group’s Asia life insurance division. Here you can see the effect that big corporations have on the currency movements. Because Prudential is based in the UK, they must exchange their pounds for US dollars in order to complete the transaction. You can just imagine how many pounds they will need to unload just to come up with enough dollars to finance the deal!

Secondly, recent polls reflect the increasing possibility of the May elections resulting in a hung parliament. A hung parliament is a situation where the minority party is in charge of the government. Now, without getting into the political nitty gritty, let me explain how this could raise some issues. Because the party would be holding just a minority power in the government, they’d need to garner support from other parties in order to pass certain laws.

Of course we all know how difficult it is for politicians to play nice to each other, so this could lead to a delay in passing laws. More specifically, this has raised concerns on how the government would actually deal with the nation’s growing debt. Take note that credit rating agencies have already warned the UK that, if they don’t get their act together, they may suffer a downgrade in sovereign debt.

Come Thursday, all ears will be on the Bank of England‘s interest rate and asset purchase facility decision. While headmaster Mervyn King and the other bank principals are widely expected to maintain the bank’s benchmark rate of 0.50%, much interest will be focused on the bank’s future policy, most especially with its QE program. During their last meeting, the bank’s MPC decided to pause their £200 billion bond-purchase program but left open the possibility of expanding it again once the economic conditions in the UK warrant it.

As the election draws near, the uncertainties in the UK market have been heightened. Given the country’s tense political situation brought about by its poor fiscal health, the higher the chance that the BOE will expand its asset purchase program. You see, an influx of money in to the market usually leads to more spending. With the British government’s mountain of debt, where the heck will they get the cash to service their obligations? One word: Taxes. That’s right… more consumption, more taxes. I’m not saying that the bank will extend their program, but it’s a possibility.

Let me bet Cyclopip‘s one eye that, over the next couple of months, economic activity in the UK would continue to remain subdued. Unless UK’s government manages to spur jobs growth and the BOE contains inflation, consumer spending would remain weak and put a serious cap on economic expansion.

As for the UK’s domestic currency… well, judging from the ugly state of its economic fundamentals, along with the rumor going around that the BOE would expand its quantitative easing program, it looks like the pound may continue dropping like a rock. Before we know it, the pound bears could be having a nice little tea party at last year’s lowest price levels at 1.3480…