British Pound Rises as Real Estate Market Improves?

The British Pound recently touched a 3-month high against the US Dollar, and market players are betting the currency’s run will continue: “Traders are paying a 0.25 percentage-point premium for one- week call options on the pound relative to puts, according to data compiled by Bloomberg.” In other words, more investors believe the Pound will rise than believe it will fall.

The Pound is faring especially well against the Euro, and the possibility of parity is becoming increasingly remote. “ ‘There are more and more people thinking there will be prolonged declines in the euro, especially against the pound,’ ” summarized one analyst.
Bulls attribute the sudden strength to an improvement in the real estate market. “A survey from the Royal Institution of Chartered Surveyors (Rics) found that new inquiries in the housing market had increased for the fifth consecutive month in March, ” en route to breaching a six-year high. Mortgage lending, which would necessarily be required to support this increased demand, are also rising, albeit from an “abysmal low.” Meanwhile, prices are still falling in the majority of markets, and real estate agents remain pessimistic.
The economic picture is still grim. A review of the UK economic timeline reveals that while the financial sector seems to have (been) stabilized, most economic indicators continue to trend downwards. “Economists predict the Treasury will anticipate a 3-3.5 percent slowdown in the economy this year, much more than a forecast in November for a 0.75-1.25 percent slowdown.” The budget is scheduled to be released later this week, and analysts expect a wide budget deficit that will need to be fueled by an increase in borrowing and/or the printing of new money. Speaking of which, the Bank of England is in the same position as its counterparts in the EU and US, which implies that the Pound should be trading at a consistent level with the Dollar and Euro.
In short, it’s difficult to ascertain whether the Pound’s recent upside is a product of technical factors or a genuine improvement in the fundamental situation. On the technical side, the currency had probably become oversold from irrational risk aversion, and the current rally could represent a pullback. Until there is definitive evidence that the British economy has turned the corner and/or that the BOE plan shows signs of success, I would advise skepticism.

Posted by Adam Kritzer | in British Pound | 1 Comment »

Pound Moves up Cautiously as Risk Aversion Declines

Mar. 27th 2009

Since touching a fresh 24-year low in the beginning of March, the British Pound has recovered strongly, rising 5% against the USD in a matter of days. Analysts are at a loss to explain the sudden strength of the Pound, outside the confines of the safe-haven hypothesis: “The risk premium that sterling has taken on works both ways, and you can see sterling outperforming whenever risk appetite picks up.”

As another analyst points out, however, ascertaining the role of risk aversion in the markets has become somewhat circular: “Observers…draw this assessment purely from price action. Rising equities means the market is less risk averse. And the way we know there is less risk adversity is that the stocks have rallied.” Applying this argument to forex, softening risk aversion is contributing to a stronger Pound. At the same time, observers point to the rising Pound as a signal that risk aversion has softened. In short, the safe-haven trade is surely not the most convincing explanation.

In fact, by all accounts, the Pound should be falling. The latest data shows that retail sales plunged by 1.9% on a monthly basis. GDP is projected to fall to such an extent that “in 2009 Britain will slip to 12th place (from 7th in 2007) among the 15 ‘old’ members of the European Union, behind all except Spain, Greece and Portugal.” Meanwhile, the Central Bank of the UK has warned that Britain’s government finances have become so fragile that the government will have difficulty carrying out new spending plans. Investors have taken note, and demand for the latest auction of UK government bonds is believed to be the “lowest in history.”
Given all the bad news, perhaps the Pound’s recent rise can be best attributed to technical factors. “The $1.45 level represents so-called resistance on a descending trend line connecting the January high of $1.5373 and the February peak of $1.4986.” Given that the Pound has since sunk back below $1.45, it can be reasonably discerned that a cluster of sell orders were executed at this level.
Over the longer-term, the prognoses for the UK economy generally, and the Pound specifically, are not good. Thanks to a low exchange rate, inflation is actually rising. It is perhaps a welcome development, since it indicates that the UK was (temporarily) averted deflation, but it could also be a product of the quantitative easing plan announced earlier this month, whereby the Bank of England will flood the banking system with newly minted money. “Such a tactic can dilute the currency, and the perception that such dilution is about to occur is dragging the Pound down right now.”