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The currency markets have not been a restful place over the past few months, and that was particularly true last week, note Barclays Wealth analysts. Foreign exchange trading has become very volatile, driven by the extreme stances on monetary policy being taken in the US and Europe, and worsened by low liquidity in the markets as the year draws to a close.
Last week, the pound showed how sharply it has weakened in the international markets, falling to a record low on a trade-weighted basis. Against the Bank of England’s records, which date back to 1990, the pound hit an all-time low against a basket of currencies.
The trend is particularly pronounced against the euro, where the pound has nearly hit parity in recent days. The record high was 95.56 pence.
And finally, sterling continued to fall against the dollar – it is now way adrift of the $2-plus levels that tourists to the US enjoyed as recently as July this year.
The pound weakened after Bank of England deputy governor John Gieve said that monetary policy alone may not be enough to shield the UK economy from the effects of the credit crunch. He warned that interest rates were a ‘blunt tool’, and confessed that the Bank had failed to understand the severity of the problems facing the UK economy before the financial crisis.
Barclays Wealth analysts find hard to disagree with the general sense of gloom. “Looking forward, we expect sterling to remain troubled for at least the first half of 2009. The UK economic outlook is weak, rates are likely to fall further, and there are concerns about the rapid growth of government debt.
The UK is likely to be hit harder than either the US or the rest of Europe by the lingering effects of the credit crunch. We doubt that the UK economy will start growing again before the fourth quarter of 2009, write Barclays Wealth analysts.
The UK’s economic prospects have deteriorated to the extent that the Bank of England has slashed interest rates from 5% to 2% in an attempt to prevent a severe recession. And it is likely to cut them further: Barclays Wealth analysts expect UK rates to fall to 1% by spring 2009.
Accordingly, sterling is seen remaining very weak against the US dollar. In the very short term, sterling could fall towards $1.40 if, as Barclays Wealth analysts expect, the dollar regains strength in the New Year – although short-term forecasts are tricky at the moment, because markets are very volatile and not very liquid.
In three months time, Barclays Wealth analysts expect to see only a slight recovery to $1.53. But in the longer term, if the global economy recovers more quickly than expected, helping risk appetite to recover and commodity prices to strengthen, then sterling could move towards its long-run fair value of $1.75.
In the European markets, Barclays Wealth analysts think the euro has been over-bought, and expect the pound to regain some strength against the euro over the coming months. Europe faces a downturn too, and its major export markets in Eastern Europe will be slow to recover. “Our three-month forecasts against the pound is for a fall to 85p,” conclude Barclays Wealth analysts.
