Sterling Proving No Refuge as King Eyes Stimulus While Gilt Yields Plunge
Britain’s allure as a haven is crumbling as global investors desert sterling amid the lowest inflation-adjusted bond yields on record and a faltering economy.
Amid a background of rioting and looting across the nation, Chancellor of the Exchequer George Osborne said on Aug. 11 that the U.K.’s recovery will “take longer and be harder” and Bank of England Governor Mervyn King signaled a day earlier he may resume pumping cash into the economy to boost growth. Investors have responded to the worsening outlook by pulling money out of the country at the fastest rate in at least two decades.
Traders are betting on pound weakness even as the euro-area debt crisis deepens because of slumping consumer sentiment and a growth rate that may trail behind Germany’s by more than two percentage points in 2011, analysts in Bloomberg surveys said. Analysts cut forecasts for sterling versus the euro by 5.7 percent this year, the most of 17 developed-nation pairs tracked by Bloomberg.
“I remain structurally quite bearish on sterling,” Stephen Gallo, the head of market analysis at Schneider Foreign Exchange Ltd., the most-accurate currency forecaster in a Bloomberg survey, said in an interview. He expects sterling to weaken more than 8 percent against the 17-nation euro by year- end. “When you compare growth potential in the core of the euro area with the U.K.’s, the former’s is actually much better.”
Weaker Sterling Predicted
Sterling may depreciate to 96 pence per euro by the end of 2011, London-based Gallo said by e-mail last week, from 88.14 pence today. The pound rose 0.7 percent to $1.6390 at 2:05 p.m. in London. It slid to a record low 1.1470 francs on Aug. 9 and has dropped 11 percent this year against the Swiss currency.
Obstacles to an economic recovery are intensifying “by the day” and “weakness in underlying activity is likely to be somewhat more persistent than previously expected,” King told reporters in London on Aug. 10. “The recovery will take longer and be harder than had been hoped,” Osborne said in Parliament in London a day later, while defending his plans to cut the budget deficit.
Prime Minister David Cameron and Osborne addressed lawmakers last week during an emergency session called to debate the riots in England, which started on Aug. 6 in the north London suburb of Tottenham and spread across the capital the following night and then to cities including Birmingham. Cameron broke off his holiday in Italy to return to deal with the violence, which he described as criminal.
Economic Laggard
Britain’s economy will probably grow 1.2 percent this year, behind a 3.4 percent expansion in Germany and 1.8 percent increase in the U.S., according to Bloomberg surveys. Even with the Greek and Portuguese economies contracting, euro-region gross domestic product will climb 2 percent, a separate survey shows. The U.K.’s expansion was 0.2 percent last quarter after stagnating in the six months through March, according to government figures.
Investors sold a net 48.9 billion pounds ($79.6 billion) in U.K. stocks, bonds and money-market products in the first quarter, adding to the 55.3 billion-pound outflow in the previous three months, according to the most recent data from the Office for National Statistics in London. The next biggest outflows were in the third quarter of 2005. Sterling declined 1.2 percent then on a trade-weighted basis, according to a Bank of England index.
Gilts, Treasuries
Osborne, writing in the Daily Telegraph on Aug. 8, hailed the “credibility” of his austerity plan, which may fend off the loss of the nation’s AAA credit rating. He cited the U.S. rating cut and Europe’s debt crisis as “vindication” for the biggest fiscal squeeze since World War II.
U.K. government bonds underperformed Treasuries, and the pound fell against the dollar and the euro last week after Standard & Poor’s removed the U.S.’s AAA rating on Aug. 5 and European Central Bank President Jean-Claude Trichet began buying Italian and Spanish bonds to contain the debt crisis, which threatened to engulf the currency area’s third and fourth- largest economies. The Federal Reserve pledged last week to keep its benchmark rate near zero until at least mid-2013.
The Bank of England’s benchmark rate is 0.5 percent, 1 percentage point lower than that of the ECB, which boosted its refinancing rate twice this year.
The pound has declined 2.3 percent against the euro this year as the sovereign-debt crisis spread, pushing borrowing costs in Italy and Spain to euro-era highs relative to German bunds (sic) this month.
‘Growth Outlook’
Gilts, which are about 70 percent owned by local investors, making them less sensitive to currency swings, have returned 2.49 percentage points more than German bunds this year as the economy slowed. Foreigners hold 49 percent of U.S. Treasuries.
For Ken Dickson, investment director of currencies at Standard Life Investments in Edinburgh, there will be demand for sterling as long as the euro area’s debt crisis persists and the Fed keeps rates at record lows.
“The austerity measures are good for the ratings, but in the markets’ eyes they are also undermining the growth outlook,” Dickson said last week by telephone. “Had the U.K. been the only economy suffering this way, it’s likely that you’d see pound weakness because you’d expect monetary policy to remain loose. But much of the developed world is in the same boat.”
Standard Life, Scotland’s second-biggest money manager, is “neutral” on sterling against its major peers, Dickson said.
Euro Stronger
The U.K. is estimated by S&P to have a debt-to-GDP ratio this year of 80 percent, 6 percentage points higher than the U.S. In contrast with America, Britain’s net public debt is forecast to decline by 2015, the ratings company said in a statement accompanying the U.S. downgrade.
That hasn’t kept the pound from losing 8 percent over the past year against nine major peers tracked by the Bloomberg Correlation-Weighted Indexes, the biggest loser after the dollar. The euro is little changed, while the Swiss franc jumped 20 percent.
“The euro zone is an economy that, on aggregate, does look stronger than the U.K.,” Sara Yates, a London-based strategist at Barclays Plc, said last week by phone. Yates predicted that the pound would weaken to 95 pence per euro in three months. “Sterling looks more vulnerable. When you look at the fundamentals of the U.K. economy, it’s very weak.”
‘B for Bankruptcy’
Sagging growth prospects prompted strategists to reduce forecasts for the pound against the euro each month since the end of March as the government vowed to eliminate the bulk of the budget deficit, which reached a record 11 percent of gross GDP in the year ended March 2010, by 2015. Analysts predicted the pound would end the year at 84 pence per euro as of March 31, according to a median forecast compiled by Bloomberg. It was 85 pence on April 29, 86 pence as of May 31, 87 pence on June 30 and 89 pence as of July 29, the data show.
Cameron rejected calls to slow spending cuts, saying on June 20 that “a Plan B would stand for bankruptcy.” The government will miss its target of balancing the nation’s books in 2015-2016 by around 1 percent of GDP, the National Institute for Economic and Social Research, whose clients include the U.K. Treasury and the Bank of England, said on Aug. 3.
Inflation may undershoot the central bank’s 2 percent target, King said last week. “If we need to, we can carry out more asset purchases,” he said. The bank bought 200 billion pounds of debt from March 2009 until January 2010 in a policy known as quantitative easing, designed to cap borrowing costs and stimulate the economy.
Real Yields
U.K. manufacturing contracted 0.4 percent in June and the trade gap widened, government reports showed on Aug. 9. That deepened concern that spending reductions and Europe’s debt crisis may undermine the recovery.
Consumer-price growth was 4.2 percent in June, with gilts due in 10 years yielding 1.72 percentage points less than inflation on Aug. 10, the most since at least 1992, according to data compiled by Bloomberg. That compared with a minus 0.27 percentage-point difference last week in Germany, Europe’s biggest economy. The so-called real yield in the U.S. is minus 1.3 percent, with Japan at 0.84 percent.
“What has been keeping the pound afloat is the aversion to holding dollars or euros,” Vassili Serebriakov, a New York- based currency strategist at Wells Fargo & Co., the third-most accurate forecaster in the six quarters through June, said last week by telephone . “Fundamentally the pound remains unattractive because real short-term interest rates in the U.K. are among the lowest” in the Group of 10, he said.
Reporters on this story: Lukanyo Mnyanda in Edinburgh; Allison Bennett in New York.
Editors responsible for this story: Daniel Tilles; Dave Liedtka.
