Is The Drop In The Pound Sustainable?

Includes: FXB, FXE
by: Elite E Services

Today the Great British Pound (NYSEARCA:FXB) dropped against all other currencies, as much as 1.8% against the Euro.

The pound slumped the most in more than two years against the euro after an industry report showed U.K. manufacturing grew less in January than economists forecast, sapping demand for Britain's currency as a haven.

"The pound is in a perfect storm," said Arne Rasmussen, the head of currency research at Danske Bank A/S (DANSKE) in Copenhagen. "The momentum for its weakness is building as the economic outlook is poor, and the safe-haven status is diminishing given the improvement in sentiment towards the euro. With the new Bank of England's chief testifying next week, the market is nervous."

Also, economic data coming from the region has been negative, such as the recent gauge of U.K. manufacturing by the Chartered Institute of Purchasing and Supply, in which output fell to 50.8 from 51.2 in December.

The pound has also been weakened by fears about the UK's AAA credit rating.

This follows after credit rating agency Fitch warned last month that the UK could lose the top rating if the government does not reduce its sovereign debt.

Continuing concerns about the UK economy, which contracted by 0.3% in the final quarter of 2012, have also hit sterling.

All of this brewing bad news culminated in today's severe drop.


To see the veracity of this move, look at the below EUR/GBP chart. This is an hourly chart, it shows a move from .8593 to a peak of more than .8720 in 12 hours.

But looking at the entire hourly chart, you can see it's outside the normal volatility of the pair.

In fact, the EUR/GBP pair is one of the least volatile pairs.

Looking at a chart of GBP/USD it's not so bad, although there was the same decline - it's roughly where the pair was a few days ago.

Fate of British Pound (FXB)

The real question for the British Pound is what will be the next event driving it to the next level? Against the US Dollar it's reached a short term support. This is similar to GBP/AUD which also shows short-term support. The big exceptions are EUR/GBP and GBP/NZD which are in uncharted territory, technically speaking.

This move in the British Pound is a fundamental one, not a technical one. But traders are left with few clues as to the direction after such a severe drop. Institutional traders and analysts agree the decline will continue, with the exception of RBS:

Royal Bank of Scotland Group Plc suggested investors buy the pound against the euro, betting its slide is about to end.

Royal Bank of Scotland said Draghi's comments at next week's policy meeting may temporarily halt the euro's advance.

"Recently the euro has rallied on LTRO withdrawal" and measures to contain the region's debt crisis, Greg Gibbs, a senior currency strategist at RBS in Singapore, wrote in a note to clients. "The risk is now that the market has built all this in and that Draghi may shift to noting risks to the economic outlook."

As contrarians, we normally would agree here with RBS. There should be some retracement just due to normal Forex market mechanics. However, we would suggest waiting for the next key information before deciding about the British Pound. It's not yet proven itself as a steady decliner, as the Yen recently did. The Yen's decline, albeit slow and steady, is a near guarantee, due to the new government policy. This is not the case with the British Pound.

Market data to watch next week

As to the key data points that will indicate direction in the British Pound they are:

  • Feb 7th ECB policy meeting
  • Feb 7th BoE Asset Purchase Facility
  • Feb 7th BoE Interest Rate Decision
  • Feb 7th NIESR GDP Estimate (3M)

Traders who either have positions in the British Pound or who are looking at establishing them, should be prepared before February 7th, 2013, when multiple data points should provide a clear direction of a reversal or continuing slide in the British Pound.

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The risk of loss in trading foreign exchange markets (FOREX), also known as cash foreign currencies, or the FOREX markets, can be substantial.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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