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The British pound rebounded from previous lows suffered against the dollar, euro and other major currencies on Monday, helped by the opening up in European markets.
European traders bought sterling at discounted prices after it collapsed in what appeared to be a “flash crash” during the session in the Asian market, notoriously less “liquid” in UK assets than the European and US markets.
The FTSE 100 was the only major market to post gains early in European trading, a sign that UK assets have now been significantly devalued on the back of Sterling’s fall.
The sell-off in the Asian session was quick and violent, typical of a low-liquidity market.
It could be that Asian traders were taking into account the sterling sell-off seen in Europe and the US on Friday, which of course was out of business hours.
If the pound recovers from here, it could signal the beginning of the end of the pound’s recent instability.
Of course, this statement comes with significant caveats, given how feverish the mood is right now.
The pound-euro exchange rate was seen back at 1.1070 after being as low as 1.0793 at the start of the session, with bank account transfer rates at around 1.0848 and the rate offered by independent providers at around 1. 1036 lie.
The pound-dollar exchange rate was back at 1.0691 at the time of publication, having hit a record low of 1.0348 during the Asian session. Bank Wire rates are trading towards 1.0475, while independent providers are in the 1.0658 area according to our data.
Above: GBP/USD (above) and GBP/EUR (below) in 15 minute intervals. To better time your payment requests, set your exchange rate alert here.
“Aggressive GBP moves overnight will be moderated somewhat as European markets open up. The sterling retracement coincides with a much more hawkish BoE rate path and broad sell-side expectations of a rate hike between meetings,” said Simon Harvey, head of FX research at Monex Europe.
The “sell side” referred to here are analysts at major investment banks, such as Deutsche Bank’s George Saravalos, who have argued that the Bank of England must step in now by aggressively raising interest rates.
The bank is not due to meet until November and Saravelos suggests action would need to be taken sooner to “restore credibility”.
Tatjana Punhan, Deputy Chief Investment Officer at Tobam, agrees the Bank of England would likely need to intervene before its next official policy meeting.
If they don’t, she suggested that monetary policy committee members “should lose their jobs”.
Martin Malone, chief economist at Auriel, says much of the blame for sterling’s decline lies with the Bank of England.
The Bank of England “is not involved at all,” Malone said in a Bloomberg interview on Monday.
He said the Bank of England “made a huge mistake on Thursday” by opting for just a 50 basis point hike while the Federal Reserve had risen 75 basis points a few hours earlier.
In short, the bank continues to be “leveraged” by the Fed and indeed most other central banks. But he says the bank will have to wait until November to rise, however, and says an inter-meeting rate hike would come from a position of weakness.
Malone says the government’s strategy of boosting growth through changes in fiscal policy is actually “positive.”
The British pound suffered significant losses during Monday’s Asian session, contributing to Friday’s massive sell-off and making for record lows against the dollar and a move below 1.10 against the euro.
Analysts say the pound’s weakness comes as traders bet the UK government will be unable to fund its debt burden while the Bank of England refuses to hike interest rates as much as it can the market demands.
The falling pound coincides with rising debt costs in the UK as investors sell government bonds, boosting their yields.
The sell-off in both the currency and bonds follows the UK government’s announcement that it will cut taxes at a time when it has significantly increased spending to limit energy bills for households and businesses.
Economists theorize that this combination means the government will inevitably be unable to borrow the amounts of money needed to meet its goals.
But is the pound in a real crisis or has a long overdue downward correction taken place?
Addressing talk of a looming sterling crisis, Paul Krugman, a Nobel laureate with extensive experience in currency crises:
“I should know about currency crises – I invented the academic field! And as far as I know, there are two ways that a country with a floating exchange rate can have a currency crisis, neither of which apply to the UK,” says Krugman.
“Since the 1990s, most currency crises have had balance sheet implications: a country (either public or private, or both) has large external liabilities denominated in foreign currency. In this case, devaluation worsens balance sheets and creates a self-reinforcing downward spiral. ” he explains.
“While the UK has many external liabilities, these are predominantly denominated in sterling; the UK also has foreign assets, mostly direct investment
“The result is that the devaluation of sterling actually *improves* Britain’s net international investment position (the same thing is happening with the US). A currency crisis story on the balance sheet does not seem to make any sense
“The other way you can have a currency crisis is when the markets think you can’t or won’t service your national debt and you’re going to monetize it instead; that was the story behind the 1926 franc crisis and, I believe, the 1976 sterling crisis (which needs to be reconsidered) 7
“But the Bank of England is independent these days and is unlikely to monetize debt. And despite everything, the UK debt is not *that* high in a long-term comparison
“Presumably the risk premium for idiots is now priced in. I don’t think I see any mechanism for a prolonged sterling crisis.”
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