Few would argue the UK faces one of its toughest ever economic challenges this year, and the country’s currency has reflected this: hitting a 23-year low against the dollar and a record low against the yen.
But other economies are in poor condition, so why has the pound suffered more? Has its sell off been overdone, or are UK finances in such poor shape sterling’s descent is fully warranted?
Maurice Pomery, head of FX at IDEAglobal, answered readers’ questions on the plight of sterling and the fortunes of other currencies on Monday, February 2.
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It seems every bit of news this day hits the pound against other currencies. I hear the British government believes this will help the economy since it would make British goods cheaper. I am wondering as to the rationale behind this lack of support to the currency. Last time I checked, the UK was importing more than exporting and was a service-based economy not a manufacturing oriented one. Consequently do you believe the UK government to be likely to back the pound at some point in the next 3 to 6 months and to what extent such public showing could strengthen the currency?
Marc, London
Maurice Pomery: This is a very good question and I have often said that lowering the value of sterling to help exports requires a strong export infrastructure and someone to export to.
The UK is just not in this business to the extent it was and although it worked in the past after the demise of the exchange rate mechanism, the structure of our economy has shifted.
Weaker sterling makes life very tough on our retailers, as we import so much, at a time when consumers are demanding ever-bigger discounts and bargains.
However, I think there is little this administration will do with the Pound in the medium-term as Mr Brown himself has quickly moved to rebuff comments from the French finance minister that the government should intervene to stem the fall as it is uncompetitive.
But if sterling starts to collapse on a trade-weighted basis, the political pressure from Europe for action will rise and, with the UK’s lack of reserves, any action may have to be co-ordinated across the continent.
My own opinion is that the government likes a lower pound to attract back the foreign investment from banks and major institutions to prop up the Gilt market and underpin the financial sector.
--------------------------------------------------------------------------------------------------------------------
Why is the US dollar, with a crisis to at least match that of the UK in housing, in trade and in the government budget overspend, not to mention even lower interest rates, doing so much better than the UK?
Francis Toye, London
MP: The plain fact here is that we have gone through a massive shortage of US dollars as banks struggled to borrow and that, with the financial turmoil we have seen, a massive disinvestment from global markets has taken place.
This de-leveraging has seen money move home and investors clamour for the safety of what can be called ‘the world’s reserve currency’. The dominance of the US bond markets has attracted money that is now more interested in safety than in yield.
---------------------------------------------------------------------------------------------------------------------
In terms of foreign currency, where does one go for a safe haven? Is the best option the Swiss franc?
David Nichol, UK.
MP: The emphasis on the Swiss franc as a safe haven currency has been diluted recently and the correlation between risk aversion and Swiss strength has been somewhat tarnished.
As this financial and economic situation is a global event, investors have turned to the US dollar as the world’s reserve currency and as interest rate differentials have narrowed, have been more inclined to buy into the creditor nation status that is the Japanese yen.
Again this is more about safety, even on a Sovereign basis, than yield.
-------------------------------------------------------------------------------------------------------------------
I am reading that with the demise of both London as a global financial powerhouse and the tailing off of North Sea reserves, the UK is not the place for future investments. Sterling has dropped significantly and some say will go down further to parity against the dollar as well as below the one-euro level. I can understand the rationale behind this sentiment, but would like another view to see if this is on the cards.
Richard Marshall, London
MP: My personal view is these comments are from the hyper-pessimists and the financial infrastructure is still a very compelling story with a talent pool that is till the envy of the world.
It will remain important for financial services companies to do business in London. We have seen confidence tested before.
I do not see London going from being the best trading centre in the World to nowhere- at-all so quickly, and possibly new investment is already being attracted by the weaker pound.
I feel there is a lot already “priced in “ in terms of the current level of sterling, and the UK currency even seems a little undervalued against the euro.
Against the US dollar, sterling’s prospects are a little more opaque and lower levels could be seen.
But I see no run on the pound yet. Any step-down for sterling against the dollar will see most currencies follow it, including the euro.
---------------------------------------------------------------------------------------------------------------------
What is really the driver behind the currency volatility of the past few months? It seems that underlying fundamentals are less important, and also that with interest rates now being so close to zero that foreign exchange trading is one of the few ways for investors and institutions to generate tax free profits or returns . Does this mean that currency volatility is likely to continue; what is your perspective on this?
Peter Russell, Hungary
MP: Quite simply the elevated volatility in markets has been based on fear and de-leveraging with a lack of liquidity in the market.
This will last some time as there is a massive split in opinions as to what is around the corner in both political initiatives and reactions to them.
---------------------------------------------------------------------------------------------------------------------
Has the banking crisis in the UK severely damaged the UK position as a leading finance centre and if so will this and the weak manufacturing position in the UK result in the current weak pound sterling becoming a permanent state of affairs?
Ian Mayger, Watlington Oxfordshire
MP: The banking crisis has not done any favours for the UK’s position as a leading financial centre, but I would argue against it being severely damaged.
The government, the Bank of England and the Financial Services Authority (FSA) are implementing measures to stabilise the financial system and restore confidence in the banking system; via bank recapitalisation measures (amounting to £37bn in fourth quarter of 2008), nationalisation or part nationalisation of some banks, taking measures to provide liquidity insurance to banks in the event of stressed market conditions.
Also from February 2, the Bank of England will start purchasing of high quality corporate bonds, commercial paper and paper issued under its capital guarantee scheme (all high quality assets and paper that enjoys genuine private demand in normal conditions).
Even the FSA has already acknowledged that it would have to accept a lower capital adequacy requirements for banks, as the latter absorb expected losses stemming from prospective bad loans as a result of the weakening economy.
Don’t forget that New York has also been in the eye of the storm, perhaps even more so than the UK, and the key financial centre in the eurozone, Frankfurt in Germany, has also had its fair share of banking sector problems.
With time, once stability is restored, with tighter regulation in place, London will enhance its role as a key financial centre.
In fact it still is a key financial centre, even after the recent debacle.
In its favour are demographics, a universally spoken language, a flexible labour market and its favoured location between New York and Tokyo.
But it will probably take several years before it resumes trading at the capacity at which it did prior to the financial turmoil.
--------------------------------------------------------------------------------------------------------------------
What were the reasons for the sell-off of gold by the UK government at a time when the price was at a long-term low? Was it debated in the commons?Who made the decision? How much more would have been raised if the same quantity was sold now?
Tony Crampton, Brittany
PM: The government decision to sell 415tonnes from its holdings of 715 tonnes of Gold reserves in 1999 came in the aftermath of sales of gold reserves by a handful of central banks.
It was felt at the time that it wasn’t necessary for the government to hold the bulk of its currency reserves in gold. So what it did was to reduce the proportion of its holdings of gold in favour of increased holdings of other currencies. So, the intention was for gold holdings to fall to around 7 per cent of total reserves, from 16.7 per cent.
Recall that this decision was taken against the backdrop of a continuous fall in the gold price, from $413.5 per troy ounce in Feb 96, to $282.5 per troy ounce on May 7 1999, when the govt made its announcement.
The price carried on falling right through to September 1999. So the government would have felt it was prudent at the time to make such a decision. Indeed, the Treasury said “its aim was to balance the portfolio of Britain’s reserves by increasing the amount held in currency against a background of falling gold prices”. It was also felt that with nearly 50 per cent of the UK’s net foreign currency reserves invested in gold, prior to the sale, the exposure to a single asset (whose price had exhibited volatility historically) was too great.
Parliamentary approval of the gold sale was not sought, but the decision has since been debated a few times. Note that in Jan 2001 the govt spending watchdog (National Audit Office) did declare that the sale of the UK’s gold reserves had been successful. It is estimated that the government raised $3.5bn from the sale of gold, having sold around 395tonnes between 1999 and 2001.
But it’s been claimed that the sale cost the UK £2bn because the UK did not capitalise on the subsequent soaring of gold prices from March 2001
Source : FT
But other economies are in poor condition, so why has the pound suffered more? Has its sell off been overdone, or are UK finances in such poor shape sterling’s descent is fully warranted?
Maurice Pomery, head of FX at IDEAglobal, answered readers’ questions on the plight of sterling and the fortunes of other currencies on Monday, February 2.
--------------------------------------------------------------------------------------------------------------------
It seems every bit of news this day hits the pound against other currencies. I hear the British government believes this will help the economy since it would make British goods cheaper. I am wondering as to the rationale behind this lack of support to the currency. Last time I checked, the UK was importing more than exporting and was a service-based economy not a manufacturing oriented one. Consequently do you believe the UK government to be likely to back the pound at some point in the next 3 to 6 months and to what extent such public showing could strengthen the currency?
Marc, London
Maurice Pomery: This is a very good question and I have often said that lowering the value of sterling to help exports requires a strong export infrastructure and someone to export to.
The UK is just not in this business to the extent it was and although it worked in the past after the demise of the exchange rate mechanism, the structure of our economy has shifted.
Weaker sterling makes life very tough on our retailers, as we import so much, at a time when consumers are demanding ever-bigger discounts and bargains.
However, I think there is little this administration will do with the Pound in the medium-term as Mr Brown himself has quickly moved to rebuff comments from the French finance minister that the government should intervene to stem the fall as it is uncompetitive.
But if sterling starts to collapse on a trade-weighted basis, the political pressure from Europe for action will rise and, with the UK’s lack of reserves, any action may have to be co-ordinated across the continent.
My own opinion is that the government likes a lower pound to attract back the foreign investment from banks and major institutions to prop up the Gilt market and underpin the financial sector.
--------------------------------------------------------------------------------------------------------------------
Why is the US dollar, with a crisis to at least match that of the UK in housing, in trade and in the government budget overspend, not to mention even lower interest rates, doing so much better than the UK?
Francis Toye, London
MP: The plain fact here is that we have gone through a massive shortage of US dollars as banks struggled to borrow and that, with the financial turmoil we have seen, a massive disinvestment from global markets has taken place.
This de-leveraging has seen money move home and investors clamour for the safety of what can be called ‘the world’s reserve currency’. The dominance of the US bond markets has attracted money that is now more interested in safety than in yield.
---------------------------------------------------------------------------------------------------------------------
In terms of foreign currency, where does one go for a safe haven? Is the best option the Swiss franc?
David Nichol, UK.
MP: The emphasis on the Swiss franc as a safe haven currency has been diluted recently and the correlation between risk aversion and Swiss strength has been somewhat tarnished.
As this financial and economic situation is a global event, investors have turned to the US dollar as the world’s reserve currency and as interest rate differentials have narrowed, have been more inclined to buy into the creditor nation status that is the Japanese yen.
Again this is more about safety, even on a Sovereign basis, than yield.
-------------------------------------------------------------------------------------------------------------------
I am reading that with the demise of both London as a global financial powerhouse and the tailing off of North Sea reserves, the UK is not the place for future investments. Sterling has dropped significantly and some say will go down further to parity against the dollar as well as below the one-euro level. I can understand the rationale behind this sentiment, but would like another view to see if this is on the cards.
Richard Marshall, London
MP: My personal view is these comments are from the hyper-pessimists and the financial infrastructure is still a very compelling story with a talent pool that is till the envy of the world.
It will remain important for financial services companies to do business in London. We have seen confidence tested before.
I do not see London going from being the best trading centre in the World to nowhere- at-all so quickly, and possibly new investment is already being attracted by the weaker pound.
I feel there is a lot already “priced in “ in terms of the current level of sterling, and the UK currency even seems a little undervalued against the euro.
Against the US dollar, sterling’s prospects are a little more opaque and lower levels could be seen.
But I see no run on the pound yet. Any step-down for sterling against the dollar will see most currencies follow it, including the euro.
---------------------------------------------------------------------------------------------------------------------
What is really the driver behind the currency volatility of the past few months? It seems that underlying fundamentals are less important, and also that with interest rates now being so close to zero that foreign exchange trading is one of the few ways for investors and institutions to generate tax free profits or returns . Does this mean that currency volatility is likely to continue; what is your perspective on this?
Peter Russell, Hungary
MP: Quite simply the elevated volatility in markets has been based on fear and de-leveraging with a lack of liquidity in the market.
This will last some time as there is a massive split in opinions as to what is around the corner in both political initiatives and reactions to them.
---------------------------------------------------------------------------------------------------------------------
Has the banking crisis in the UK severely damaged the UK position as a leading finance centre and if so will this and the weak manufacturing position in the UK result in the current weak pound sterling becoming a permanent state of affairs?
Ian Mayger, Watlington Oxfordshire
MP: The banking crisis has not done any favours for the UK’s position as a leading financial centre, but I would argue against it being severely damaged.
The government, the Bank of England and the Financial Services Authority (FSA) are implementing measures to stabilise the financial system and restore confidence in the banking system; via bank recapitalisation measures (amounting to £37bn in fourth quarter of 2008), nationalisation or part nationalisation of some banks, taking measures to provide liquidity insurance to banks in the event of stressed market conditions.
Also from February 2, the Bank of England will start purchasing of high quality corporate bonds, commercial paper and paper issued under its capital guarantee scheme (all high quality assets and paper that enjoys genuine private demand in normal conditions).
Even the FSA has already acknowledged that it would have to accept a lower capital adequacy requirements for banks, as the latter absorb expected losses stemming from prospective bad loans as a result of the weakening economy.
Don’t forget that New York has also been in the eye of the storm, perhaps even more so than the UK, and the key financial centre in the eurozone, Frankfurt in Germany, has also had its fair share of banking sector problems.
With time, once stability is restored, with tighter regulation in place, London will enhance its role as a key financial centre.
In fact it still is a key financial centre, even after the recent debacle.
In its favour are demographics, a universally spoken language, a flexible labour market and its favoured location between New York and Tokyo.
But it will probably take several years before it resumes trading at the capacity at which it did prior to the financial turmoil.
--------------------------------------------------------------------------------------------------------------------
What were the reasons for the sell-off of gold by the UK government at a time when the price was at a long-term low? Was it debated in the commons?Who made the decision? How much more would have been raised if the same quantity was sold now?
Tony Crampton, Brittany
PM: The government decision to sell 415tonnes from its holdings of 715 tonnes of Gold reserves in 1999 came in the aftermath of sales of gold reserves by a handful of central banks.
It was felt at the time that it wasn’t necessary for the government to hold the bulk of its currency reserves in gold. So what it did was to reduce the proportion of its holdings of gold in favour of increased holdings of other currencies. So, the intention was for gold holdings to fall to around 7 per cent of total reserves, from 16.7 per cent.
Recall that this decision was taken against the backdrop of a continuous fall in the gold price, from $413.5 per troy ounce in Feb 96, to $282.5 per troy ounce on May 7 1999, when the govt made its announcement.
The price carried on falling right through to September 1999. So the government would have felt it was prudent at the time to make such a decision. Indeed, the Treasury said “its aim was to balance the portfolio of Britain’s reserves by increasing the amount held in currency against a background of falling gold prices”. It was also felt that with nearly 50 per cent of the UK’s net foreign currency reserves invested in gold, prior to the sale, the exposure to a single asset (whose price had exhibited volatility historically) was too great.
Parliamentary approval of the gold sale was not sought, but the decision has since been debated a few times. Note that in Jan 2001 the govt spending watchdog (National Audit Office) did declare that the sale of the UK’s gold reserves had been successful. It is estimated that the government raised $3.5bn from the sale of gold, having sold around 395tonnes between 1999 and 2001.
But it’s been claimed that the sale cost the UK £2bn because the UK did not capitalise on the subsequent soaring of gold prices from March 2001
Source : FT
