Weak British Pound Could Boost U.K. Economy

How Did the British Pound Trade in 2008?

The British pound was one of the worst performing currencies in 2008. It fell to a 6 year low against the US dollar and record low against the Euro in addition to selling off against every other G10 currency. The overwhelming weakness in the currency is a direct reflection of the impact that the credit crisis had on the UK economy. In the month of December, many currencies recovered against the US dollar, but unfortunately the British pound was not one of them. Although the pound could continue to weaken in the first quarter, the government’s aggressive fiscal and monetary stimulus should help the country recover towards the end of 2009.

Official Recession in 2009

Without two consecutive quarters of negative GDP growth, the UK economy is not technically in a recession but that should change in the first quarter of 2009, when the 2008 Q4 GDP numbers are released. Growth has been slowing materially and the weakness is reflected in the British pound. GDP growth fell by 0.6 percent in the third quarter, the largest decline in 18 years. The housing market and the financial sector have been the engine of growth in UK for the past few years and both blew up in 2008. Unfortunately the worst is probably not over for the 2 key components of the UK economy, particularly following the Bernie Madoff’s Ponzi scheme. In addition to losses suffered from the subprime mortgage crisis, many large hedge funds and European banks invested with Madoff. In 2009, they will be forced to write down those losses and deal with what could be pretty severe consequences for the financial sector as a whole. With the financial and housing market sectors expected to remain weak in the first half of 2009 and layoffs predicted to rise, GDP growth could fall as much as 2 percent next year. Although we believe that the country could be one of the first to recover from the global economic downturn, this will not be before more pain is felt in the UK economy. The severity of the UK recession will be largely dependent upon how quickly the credit markets are restored in 2009.

Inflation to Fall Back to 2%

Even though falling oil prices have driven inflation lower in the UK, the annualized pace of consumer price growth is still well above the central bank’s 2 percent target and even higher than their 3 percent upper limit. The latest data is for the month of October and according to that report, consumer prices rose 4.1 percent yoy. Despite the high level of inflation, the central bank has pretty much abandoned the inflation target and shifted their focus back to growth because they believe that the slowdown in the economy will naturally drive inflation lower. They believe inflation could fall back to 2 percent as early as the first quarter.

More Rate Cuts in First Half of 2009

Next to the Federal Reserve, the Bank of England has been the most aggressive central bank in 2008, having cut interest rates by 350bp to 2 percent, the lowest level in 57 years. Despite the massive interest rate cuts, tax cuts and other fiscal stimulus, the Bank of England remains committed to doing all that it takes to prevent a recession from sparking deflation. Central Bank Governor King believes that the economy will contract in 2009 and has given his pledge that UK interest rates could fall by another 100bp in the first half of the year. Although zero interest rates are not expected in the UK, interest rates will fall below 2 percent and until the Bank of England is done easing, the British pound may remain weak.

EUR/GBP at Parity

The sell-off of the British pound in the first few months of the year could drive EUR/GBP to parity. If that happens, it would be the first time ever that one Euro would be worth more than one British pound. This could not come at a better time than 2009, when the Euro celebrates its 10-year anniversary. In this past decade, the currency has risen from ashes to become more valuable than the 2 primary reserve currencies in the world. Although many Britons may be alarmed at the weakness of their exchange rate, the Bank of England will probably not step in to stop it from falling. Instead, the BoE will revel in the stimulative effects of a weak currency. There are already reports of Europeans from the Eurozone flocking to the UK for their holidays. The weakness of the British pound against both the US dollar and the Euro are key ingredients for an economic recovery.

Comments

[abcde_98:]

Nice segmentation of some considerations. Two cross-border items:

1. Europeans flocking to holiday in UK. Agree there will be an increase, but not so "sky high" due to : 1) UK land / features 2) UK climate/seasons 3) European customs. "Holidays" may be short trips. Can you see Europeans spend their holiday month of August switch from the culinary delights and beach/sun coasts of Spain/France/Italy/Gre... to deep fried Mars bars, beaches in the Lake District of England, or concrete architecture of Manchester, for an entire month?

2. UK residents vacationing and owning homes/condos in Euro-zone areas such as Spain/France. Firstly, vacations would be very expensive with GBP-EUR at par, so expect a reduction. Secondly, and perhaps much bigger: UK residents with mortgages on Euro-zone homes/condos they bought in the past few years ... the mortgage amount and payments would be in Euro's, but the GBP has declined 50%+, to make those mortgage payments will cost the UK citizen say 25-50% more of their 'spare" cash. I doubt very few individuals put a hedge on the GBP-EUR rate. Furthermore, there could be negative equity in some properties since house/condo prices have been falling in some areas, and perhaps will fall beyond the mortgage amount. What will these UK owners do in such situation? It's likely that many have done nothing so far since, the exchange rate decline was initially gradual and then accelerated with perhaps people thinking rates may "revert to the mean", and then there is the emotional / lifestyle aspect which is hard to give up. How significant is this ownership (eg. number or % of Britons)? What is the approx average magnitude per property? I've got to think this will have meaningful, direct and indirect, effect on Euro-zone economies.

Jan 02 09:32 AM

[Clavis:]

In theory you are probably correct but the main factor of manipulation has not been taken into account.
Shorting the pound is easier than shorting the euro, even with weak partners like Spain, Italy and Greece who have yet to meet their fiscal commitments.

Jan 02 11:56 AM

[NOWHEREMAN:]

Ms. Lien: thank you for your insights over the past year.

This article is especially useful. I know of a few Alt. Energy companies which are UK based utilizing Wave Power and Wind Power who will now be able to undercut the competition.

I haven't followed them in a while so your article was a reminder.

Jan 03 06:49 AM

[NOWHEREMAN:]

Another Crude Pinelli post: "Honestly yadda yadda Lien apparently only needs her picture posted for her resume...truly lame girl".

Is this why you stay away from Articles which have a lot of comments? So you can get away with this kind of chicanery? What was in your profile that was true?

Jan 03 05:42 PM

[NOWHEREMAN:]

You talk about Ms. Lien but your Profile leaves a lot to be desired.

A. no degree
B. a recent post of yours " I have been investing for 40 yrs" on Dec. 31st, 2008.

So what is in your Profile that has anything to do with "Honesty". IMO

Jan 03 05:54 PM

[abcde_98:]

Everyone, let's
1. stay on topic ... i'd like to think Seekingalpha's msg forums are better than weeding through many spam--ish and negative/zero-'added'-... posts on Yahoo
2. have (somewhat) balanced commentary... try to see the positive and negative side of authors' comments. I'm not perfect at this especially with ECB's rather weak (imo) rationale to not reduce rates

Criticism is good, no offence taken, appreciate feedback as it can present other considerations for analysis

Jan 05 09:38 AM