In the wake of a stagnant UK economy, aided by severe public spending cuts, the typically steadfast-sterling has been struggling to stay afloat.
Business confidence in March dropped to its lowest level in two years, putting significant pressure on the British currency. Investors were made especially anxious early last week when the pound hit a two-month low against the dollar, dropping to $1.5934.
Meanwhile, it was revealed that the Consumer Price Index (CPI) annual rate of inflation rose to 4.4 percent in February. The Retail Price Index (RPI) also rose, jumping to 5.5 percent, the highest level in 20 years. According to the market research agency GfK NOP, which carries out polling on behalf of the European Commission, UK consumer confidence stayed close to its lowest level since March 2009, holding at minus 28 for February.
The pound has since bounced back slightly, oscillating above $1.6. But, as Geoff Yu, foreign exchange strategist at UBS, said Wednesday, “The pound has given up all of its gains.” Yu argued that the “shift of expectations over interest rates” has helped to weaken the pound. “Short-term a lot will depend on policy expectations,” he added.
In light of the excessive inflation rate, investors had expected that the Bank of England would raise interest rates in the coming weeks – currently at an all-time low of 0.5 percent – in an effort to strengthen the currency. But policy makers on the Bank’s Monetary Policy Committee (MPC) appear to be divided and have not given a clear indication of how the Bank will respond.
As Paul Robinson, European Head of Foreign Exchange Research at Barclays Capital, noted, “Given the weakness of Q4 growth and the persistently high levels of inflation, the MPC is left in a quandary – does it raise rates to lessen inflationary pressures or keep policy extremely loose to protect demand?”
Moreover, the importance of government policy extends to the austerity budget that was formally announced last week by Chancellor George Osborne. The spending cuts being implemented by the Conservative-Liberal Democrat coalition government – in addition to engendering protest, rage, and broken glass throughout the capital – are hurting the overall economic growth of the country.
“The clearest impact of the spending cuts is on growth,” Bilal Hafeez, Global Head of Foreign Exchange Strategy at Deutsche Bank, said last week. The combination of rising inflation and slowing growth is particularly bad for the currency. “Generally,” Hafeez explained, “currency investors are focused on the Bank of England’s reaction. But the Bank has a relatively dovish stance, so they’re paying attention to the growth side” as an indicator of where the currency is going.
However, not all of the recent economic data has been negative. Tuesday morning, financial research group Markit released a report showing the Purchasing Managers Index (PMI) – a measurement of service sector activity – to have risen to 57.1 in March, its highest level in 13 months. The news reignited hopes that the Bank could raise interest rates this quarter, and the pound rose 0.53 percent against the dollar to 1.6218.
Robinson says the new data makes it more likely that there will have been “reasonably robust growth” in the first quarter of this year, increasing “the probability of a rate rise in May.”
But Robinson also urges caution: “One swallow doesn’t make a summer. Just as the weakness of the services sector was probably misleading to some extent, it may be that the strength of this number overstates the underlying robustness of growth.”
