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Pound pairs are naturally pretty volatile. If you look at the charts, the GBPUSD and GBPJPY make a lot of intraday movement. Still… in this recession, GBP pairs have normally followed shifts in risk sentiment – good data usually led to an increase in risk appetite, which boded well for higher-yielding currencies.

However, recent movements have left currency traders scratching their heads. These past couple of days, we have seen the AUD, EUR, NZD, CAD and CHF pairs test their yearly highs. Yet… the GBP only saw a lot of up and down movements. This past September 14 to 16, we have seen the EUR and CHF hit consecutive yearly highs while the cable dropped big time on two of those days.

What’s going on here?! Aren’t the EUR and GBP supposed to be correlated?

Don’t higher yielding currencies move hand-in-hand when we see shifts in risk sentiment?

Something fishy is going on!

Let’s take a look at the nation’s fundamentals… Amidst the recession, UK’s inflation has fallen much slower than in other countries. In a way this is good, considering that other countries have fallen into deflation. However, the huge amount of unused capacity mounted during the recession will eventually catch up…

We were given a sneak preview of this during the start of September. Activity in the UK’s manufacturing, as gauged by the PMI, dipped back to 49.7 in August from a reading of 50.2 the month prior as employers slashed jobs and inventories due to a slowdown in new factory orders. UK’s construction PMI also came in at 47.7, lower than the previous reading of 48.1.

What exactly is causing this?

The answer may lie in the lack of credit awarded to businesses and consumers. Despite the increase in mortgage approvals, the overall net lending given to individuals slipped to -£600 billion from £200 million, which was also negatively revised from £400 million.

Interestingly, both industrial and manufacturing output posted gains in July. House prices and inflation likewise registered some modest results. Moreover, Nationwide’s consumer confidence survey also turned up to 63 from 61. Well, if you’re seeing positive progress in other countries, you have got to think that you’re on the same ground too.

But is this really the case for UK?

Look at the country’s labor market. Based on the recent tally, UK’s unemployment rate now stands at a bloody 7.9% – the highest level in 13 years! Due to a freeze in credit, there is not much business to support employment. If people aren’t employed, how can we expect consumer spending to rise?

Exactly… we can’t!

BoE Governor King believes the downturn in employment would put downside pressures on the nation’s economic activity. While he expects the British economy to emerge from the recession later this year, his outlook remains clouded with pessimism. He mentioned that inflation is expected to be unsteady in the coming months and that it could downplay the strength and sustainability of an economic recovery. After all, the British economy has yet to climb out of the recession…

With the British economy trailing behind its European neighbors (France and Germany) in the road to recovery, King remains open to pumping up their easing programs. Recall that King and a couple of other policymakers lobbied for a £75 billion increase in QE but they were outvoted in the August BoE meeting.

Despite all these extraordinary measures the BoE has implemented, the problem of tight lending among commercial banks still exists. It seems that all this money being pumped into the economy isn’t reaching the people who need it the most – everyday consumers like me, you and the Queen (okay, maybe not her Highness). The BoE knows this and it does not look good for the pound. You know what they say, “Desperate times call for desperate measures.”

Just a few days ago, the pound staged a major drop against most major currencies as the BoE threatened to cut the deposit rate to pump money back into the economy. Although this rate is different from the official interest rate, cutting the deposit rate has a similar effect to lowering the benchmark rate. In essence, it would encourage banks to lend at lower rates and thus push short-term rates down.

In fact, some economists speculate that the BoE could even introduce negative interest rates and dedicate £25 billion more to the QE program by November if commercial banks continue to hoard the extra money. Remember, interest rates are already at record low levels at 0.50% and the bank has already committed £175 billion to steer UK’s economy into recovery. With this in mind, could this be the reason why the pound is getting its feet dirty in the mud while others soar higher and higher?

Are banks simply scared or just plain greedy? I don’t know for certain but these kinds of concerns are putting downward pressure on the pound even if the country’s “fundamentals” are starting to pick up.

Looking ahead, the important question for currency traders is this:

Will the pound continue to lose ground versus other majors or is this simply a chance to buy the dips?

What do you think? I’d like to hear your opinion on the matter so don’t hesitate to comment!