Cable at a tipping point.
The pound is one of those currencies that once a trend is in place it becomes very difficult to stop, particularly when markets fall out of love with it, as those of us who remember when the pound fell out of the ERM in 1992 will testify, and also the more recent declines seen when the pound dropped from highs of 2.1100 in late 2007.
In 2014 the pound fell 12% against the greenback for seven straight months, starting in July 2014 on the back of diverging interest rate dynamics as well as concerns about the Scottish referendum. After a brief rebound this downward trend re-emerged in November with the prospect that we could well revisit levels last seen at the height of the financial crisis in 2008/2009 when the pound hit lows of 1.3500, before rebounding sharply.
A large part of the reason the pound has suffered against the US dollar in particular is because of the expectation that US interest rates could either rise further, while UK rates are likely to stay anchored at the levels they’ve been at for the last 83 months, with the expectation they could stay at these levels for another 2-3 years.
Up until a month ago some surmised that Brexit concerns had hit sentiment in the pound and it was certainly an easy argument to make then, however the declines have now since gained traction across the board, though we still remain above the lowest levels on a trade weighted basis that we saw in 2009.
That being said it is now indisputable that the pound is being affected by some of the uncertainty surrounding the UK’s involvement in the European project and the upcoming referendum vote. It is also true to say that the euro is being affected as well, something the ratings agencies might do well to turn their attention to as well warning of the consequences to the UK.
It is not a zero sum game; if the EU’s second largest economy decides to leave. The belief that the Euroarea can carry on regardless is to coin a phrase used by the Prime Minister recently “for the birds”. The effect on confidence in Europe could shatter as well, if the continents second largest economy concludes the current arrangement is unworkable, and votes to leave.
This ought to be something European politicians should consider when they talk about the consequences of a UK exit, as there will be consequences for European cohesion as well. If the current agreement is the best they can come up with then even if the UK votes to stay, the current problems are only likely to be deferred.
For now the pound is at some importantly historic support levels, which if they break would represent a key technical breach of the historical range of the last 30 years, where we’ve seen the base come in around the 1.4000 area.
We now look to be on course for cable to post its lowest monthly close since early 2002. Even in the midst of the financial crisis in early 2009, despite hitting lows of 1.3500 it still managed to close the month well above the 1.4200 level, yet due to receding expectations of a rise in interest rates here in the UK it has slid over 8% since the beginning of November.
In fact in the last 30 years the last time the pound managed to close on a monthly basis below the 1.4100 level was way back in 1985, when it was on the way from recovering from its all-time low against the US dollar at 1.0520 in March of that year.
In this context these levels do mark an important area of support for sterling, which at current levels could prompt significant further losses towards the 2009 lows at 1.3500, as well as the potential to see levels last seen in the mid 1980’s, towards 1.30 and 1.20.
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