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by Kenny Fisher

The British pound has seen a lot of volatility in 2013, from as low of 1.48 up to a high above the 1.65 line. September was a stellar month for the currency, which gained over seven cents against the dollar, climbing close to the 1.62 line. The currency has saved its best for last, posting its highest levels of the year just last week.

Movement of GBP/USD in 2013

2013 Open 1.6243

2013 High - 1.6567 (December 18)

2013 Low - 1.4813 (July 8)

Monetary Policy Decisions of Bank of England:

Throughout 2013, the Bank of England made no changes to the two most important components of its monetary policy - the Official Bank Rate and the Asset Purchase Facility (QE). The benchmark interest rate remained pegged at 0.50%, while QE was maintained at 375 billion pounds. Of more interest is the breakdown in the vote by the Monetary Policy Committee with regard to QE. From January until June, the breakdown was 6-3, with BOE Governor siding with the minority who favored reducing QE. Since July, when Mark Carney replaced King as governor of the BOE, the breakdown has been a unanimous 9-0 vote. Throughout 2013, the decision to maintain interest rates at 0.50% was a unanimous 9-0 vote.

What to expect in 2014

The Bank of England revised its growth forecast for 2013 to 1.6%, up from 1.4% in a previous forecast. The BOE is predicting growth in 2014 of 2.8%. Inflation remains well above the central bank's target of 2%. The forecast for 2013 is a level of 2.6%. This is expected to drop to 2.2% in 2014.

With the British economy picking up steam in the latter half of 2013, there has been pressure on the central bank to lower interest rates. However, Carney has stated on numerous occasions that there is plenty of slack in the economy and the BOE will only consider reducing rates when unemployment falls below the 7.0% level. The unemployment rate has not dropped very much this year, from 7.8% in January to 7.6% in December. The BOE has said it doesn't expect the 7% level to be reached before 2015, but the markets feel that this could happen as early as next year, especially with strong growth forecasts for next year. If the UK economy continues to improve in 2014, the BOE will come under increasing pressure to raise interest rates.

Events in 2013

The Bank of England made a change at the very top in July, when Mervyn King was replaced by Mark Carney. As head of the BOE for 10 years, King presided over the central bank during the banking meltdown and financial crisis in 2008. King was very critical of the banking sector, and called for a review of banking structure and regulation in the UK. Carney came over after heading the Bank of Canada. Carney is a major proponent of forward guidance, which involves the public disclosure of the central bank's forecasts for interest rates and monetary policy. The aim is to increase transparency and reduce speculation and market volatility regarding monetary moves by the central bank. Carney utilized forward guidance at the BOC and has continued to use it at the BOE.

The improving British economy has been a pleasant surprise in 2013. Unemployment claims continue to fall sharply and PMI data points to expansion in the services, construction and manufacturing sectors. As well, GDP has been posting solid gains. On the negative side, consumer confidence and spending remains weak. This is understandable, bearing in mind that the UK experienced economic stagnation prior to 2013, with two years of no growth whatsoever. So consumers have not opened their purse strings wide open despite the stronger economy. As well, activity in much of the housing sector remains weak. Overall, the economy has picked up steam, and this has given a boost to the pound, which continues to trade at high levels against the dollar.

As we have already mentioned in a previous article:

In the U.S., the Federal Reserve announced last week that it would begin tapering its QE program by $10 billion a month, commencing in January. This will reduce the Fed's asset purchases to $75 billion every month, comprised of $40 billion in Treasuries and $35 billion in mortgage bonds. The announcement came as somewhat of a surprise, as most analysts had expected the Fed to hold off on any QE reductions until early next year.

In its dramatic tapering announcement, the Federal Reserve was careful to separate tapering from rate hike expectations. Fed chairman Bernard Bernanke stated that interest rates are likely to remain low even after the unemployment rate drops below 6.5%. Previously, the Fed had stated that it would start to consider rate increases when unemployment fell below this level. Bottom line? With the U.S. unemployment rate at 7.0%, it could be a while before we see higher interest rates in the U.S.

Earlier in the year Republicans and Democrats held the government hostage and played a dangerous game of brinkmanship that almost resulted in a sovereign default by the United States for the first time in its history. After weeks of finger pointing and political brinkmanship, Congress finally got its act together and voted to fund the government and raise the debt ceiling. The shutdown, which lasted for over two weeks and temporarily threw hundreds of thousands of federal employees out of work, is estimated to have cost the economy $24 billion. The cost of the debt crisis is harder to quantify, but has certainly eroded faith in the U.S. economy. This was underscored by a warning from Fitch Ratings, when the agency put U.S. debt on a negative watch. Fitch stated that the crisis had cast doubt over the credit of the United States and had undermined confidence "in the role of the U.S. dollar as the pre-eminent global reserve currency". The Republicans were the losers in this episode, as they failed to obtain any concessions regarding the Obama Health Care Act and were blamed by most of the public for precipitating an unnecessary political and fiscal crisis.

Source: GBP/USD - 2013 In Review