Fundamental Update: Can GBP make multi-year lows?

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The pound has been the second worst performing currency in the G10 since the start of this year; the speculative community is now net short sterling, for the first time since September 2012. In the short term we could see some volatility with the release of the BOE minutes later this morning along with labour market data, but in the long-term the odds seem to be stacking up for GBP. We analyse a few of the sterling negative views that are circling around the FX market right now:

1, Stabilisation in the currency bloc is pound negative:

This certainly does seem to be the case. As The Spanish-German bond spread has narrowed this has coincided with the decline in sterling. Interestingly, if you look at the CFTC non-commercial positioning data for GBPUSD, for most of the last 5 years the speculative section of the market has been net short the pound. The times when the market has been net long GBP has coincided with flare ups in the sovereign debt crisis in 2010 and 2012.Thus, stabilisation in the currency bloc looks like it is bearish for GBP.

Figure 1: CFTC data - GBP positioning over the last 12 months

Source: Bloomberg and FOREX.com

2, Bleak growth prospects:

The CFTC data also tells another story. The market has swung between being hot and cold on sterling in the last 5 years. Hot when the sovereign debt crisis flares up, cold when the market focuses on the weak prospects for the UK economy. When the market focuses on the economic outlook the pound seems stuck in a rut. In Figure 2 you can see that the market was extremely short the pound in 2009/10 as the UK was one of the last G10 nations to emerge from the Great Recession. Added to that, weak growth since the start of this year has also coincided with a sharp reversal in market sentiment towards the pound. In 2011 the market sold the pound aggressively versus the dollar, but this was partly down to the fiscal crisis in the US causing a flight to safe haven assets and a surge in the USD.

Figure 2: CFTC positioning data for GBP over the last 5 years

Source: Bloomberg and FOREX.com

3, The future for sterling

The bank of England is predicting that inflation will remain above the 2% for at least the next 2 years. This has pushed up the break-even rate (nominal Gilt yields adjusted for expected inflation) to its highest level since 2010. Today's BOE minutes could show that the BOE is concerned about inflation, yet it doesn't plan on doing more QE. In this scenario we may see the pound sold off as bonds become even less attractive for investors to hold because 1, inflation is bad news for bonds - rising yields equal falling prices, and 2, The BOE has been a major source of demand for Gilts, if it keeps its QE programme on pause a major pillar of support for the UK bond market will have been removed (or at least it won't be getting any bigger).

Figure 3: UK 5-year breakeven rate

Source: Bloomberg and FOREX.com

Is QE good for sterling?

The pound has been remarkably resilient in the face of QE in recent years, and now that the BOE is on hold the pound is falling. "But QE should be bad for the pound", I hear you cry. Indeed, for some countries that is true, but for the UK it means big inflows into Gilt yields, which is pound positive. So as investors shun Gilts this should weigh on GBP.

There is a man who could save the pound - BOE governor elect Mark Carney. If he turns on the money taps when he takes the top job in Threadneedle Street this could bring Gilt investors back to the market and boost GBP in the medium-term.

We look for GBPUSD to fall back to 1.50 in the coming weeks. If you are trading GBP and want to know where it may go next, look at the Gilt market.

Figure 4: GBPUSD and 10-year UK Gilt yields

Source: Bloomberg and FOREX.com

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957 | e: kbrooks@forex.com| w: www.forex.com/uk

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