On June 8, 2011, Moody’s, a global credit rating agency, threated that it would cut U.K.’s top-tier AAA sovereign credit rating if the country’s sluggish domestic growth continues and the Coalition government fails to meet its debt targets. Currently, U.K.‘s credit rating stands at AAA with its debt outlook “stable.”
Bad news, bad news, and more bad news – that’s what the market has been seeing out of the U.K! Let’s go through some of them, shall we?
Both the manufacturing and services PMIs came out weaker than expected.
The manufacturing PMI printed a reading of 52.1, lower the previous month’s 54.4 and the 54.2 forecast. The services PMI, on the other hand, fell to 53.8 from 54.3.
The consumer sector hasn’t been showing any strength either. The BRC retail sales monitory showed a decline of 2.1%, opposite the 5.2% gain seen the month before.
The housing market told the same story. The Halifax HPI on Tuesday, while positive, showed a puny 0.1% gain. The forecast was for an increase of 0.4%.
And most importantly, the Bank of England (BOE) has refused to hike rates despite inflation soaring to “stubbornly high” levels. The most recent CPI report of U.K. shows that the country’s inflation rate stands at 4.5%, more than double the bank’s 2.0% target!
The potential downgrade is a huge hit to the U.K. economy’s gut, as a lower credit rating will lead to higher borrowing costs. In order to entice investors to hold bonds with lower credit ratings, the U.K. government will have to offer higher yields on its gilts.
This is exactly what we saw yesterday, as gilt yields soared. Looking ahead, if yields continue to rise, it will be more difficult to raise money to help stimulate the economy and this could hurt the recovery.
How did this translate to the forex market and more specifically, pound trading?
As expected, the pound dropped like a brick in the English Channel! GBP/USD fell a solid 80 pips immediately after the news hit the airwaves!
Looking at the pound’s movement the past couple of weeks, it has been trading relatively weaker compared to other non-dollar currencies. The euro is now trading near its highs for the year, while the franc continues to print fresh all-time highs. In fact, looking at last week’s charts, the pound was the only major currency to find itself closing lower against the dollar.
Considering how weak the dollar has been and how the pound STILL haven’t been able to overtake it, then perhaps the pound is indeed fundamentally weak right now. If you are one of the brave souls who still believe in the power of the dollar, then maybe shorting GBP/USD is the way to go!