Why The British Pound Continues To Decline

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Includes: FXB
by: Andrew Sachais

Summary

Inflation in the U.K. is seeing a rapid decline in its pace of growth.

Similarly, industrial production remains on a downtrend.

As the U.K. economy continues to struggle, interest rates should remain low, weighing on the price of the pound.

The British pound has been under selling pressure in recent months as declining inflation measures, alongside weakening economic fundamentals weigh on investor expectations for an interest rate rise in the country. CurrencyShares British Pound Sterling Trust (NYSE:FXB) is down over 11% since July, as is seen in the chart below.

As inflation in the U.K. continues to fall at its current pace, regardless of the cause, it is likely the Bank of England will hold off on raising interest rates, capping potential gains in its currency. In December, the country's inflation rate figure came in at an annual pace of 0.5%, below the previous month's pace of 1.0%, as well as missing estimates for 0.7%. Since 2011, the pace of inflation in the U.K. has fallen from over 5% annually, to now nearly deflationary conditions, as is seen in the chart below. Within the figure, food and transport accounted for the largest declines.

"Prices of food and non-alcoholic beverages recorded the highest decrease (-1.7%), followed by transport (-1.4%), mainly due to a -10.5% drop in cost of fuel and lubricants. Additional downward pressures came from miscellaneous goods and services (-0.6%) and clothing and footwear (-0.3%)," according to a report by Trading Economics.

Data provided by Trading Economics

Meanwhile, in the days prior, the pace of economic growth was called into question as industrial production measures declined. In November, the industrial production figure grew by 1.1%, flat from a revised 1.0% the previous month, while missing estimates for 1.6%. Throughout 2014, to now, the figure has broadly fallen lower, as is seen in the chart below. Analysts see the disappointing industrial data as signaling an overall slowdown in the U.K. economy.

"Disappointing official data are adding to survey evidence which indicate that the rate of U.K. economic growth slowed towards the end of last year. Looking at all of the official statistics and survey evidence currently available, the data collectively point to the economy growing 0.5% in the fourth quarter, down from 0.7% in the third quarter," Chris Williamson, chief economist at data analysts Markit, told the Guardian.

Data provided by Trading Economics

Lastly, interest rates are unlikely to rise over the next few months due to the recent developments in its broader economy. Since 2009, the U.K.'s benchmark interest rate has been stuck at 0.5%, with many feeling Britain would be the first of developed world countries to begin raising rates in 2015. That does not look to be the case any longer as many now believe U.S. policymakers will begin raising rates sooner. One of the main issues plaguing U.K. inflation measures is falling oil prices, which Bank of England Governor Mark Carney believes will ultimately be a positive for the economy, he said on Wednesday.

"My personal view is that the net impact of the decline in the oil price at this stage is net positive for growth in the United Kingdom. While falling oil prices were a negative shock for the economy in Scotland, home to most of Britain's North Sea oil and gas industry, this would be substantially mitigated by the country's fiscal arrangements with the rest of the United Kingdom," Carney told CNBC.

Although oil may soon become a positive for U.K. economic data, at the moment, it is signaling a prolonged period of low interest rates in the country. As long as interest rates remain at 0.5%, alongside declining indicators in other sectors of Britain's economy, expect the pound to continue to weaken.

Data provided by Trading Economics

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.