Sterling On A Sliding Scale

I’m not in the least surprised to read that the pound is one of the most overvalued currencies in the world and will suffer in the coming year as the government ramps up spending cuts and uncertainty about Britain’s future in the EU. I have always advocated that Britain outside the EU will spell disaster for us on two fronts. The first, that our role in the political forum will diminish and our ability to influence international events will decrease to the point where our status will rapidly take the insignificant form of a second class nation. Secondly, despite what others say, our economy will suffer as result since we have always been accustomed to punch above our weight, competing with the super powers of today. The result is bound to mean that isolation, to which we are not accustomed, will hit us hard.

Analysts at Deutsch Bank warned that the Bank of England may not be able to raise interest rates at all if Britain’s recovery slows. It believes the pound could fall as low as $1.27 against the dollar next year, and $1.15 in 2017, from against $1.485 today – if the US Federal Reserve continues to tighten monetary policy and the Bank of England leaves rates on hold. ‘We have various different ways of looking at currency valuations and what we find is that sterling is the most expensive currency out there at the moment, even including the dollar,’ said Oliver Hardy, foreign exchange strategist at Deutsch Bank.

Earlier this year, the IMF said the pound was between 5% and 15% overvalued. Several bank policy makers, including governor Mark Carney and the ‘hawk’ Martin Weale, have played down the prospects that rates could rise from a record low of 0.5% in the coming months as a renewed fall in oil prices and weak wage growth keep inflation well below the Bank’s 2% target.

Deutsch Bank said more fiscal consolidation next year, relative to this year, would make it ‘challenging for the Bank of England to raise interest rates if austerity weighed on growth. Since November oil prices have fallen more and the inflation rate are showing signs of slowing, so if we don’t have a hiking cycle in the first half of next year, there is a risk that we don’t have a hiking cycle at all.’

Markets currently expect the Bank to raise the rates in January 2017. Mr. Harvey said, ‘Even if the Bank started to raise rates next year the path of hikes would be much shallower than in the US, which would push sterling down to at least $1.40 against the dollar by the end of 2016.’

Hamish Pepper, an analyst at Barclays, also warned that the Bank could kick rate rises into the long grass if ‘aggressive spending cuts over the next three years hit consumption and weigh on growth. Our core forecast is for bank rates to move higher in the middle of next year but what we are increasingly trying to emphasise is that nothing could happen at all.’

A recent YouGov survey showed household inflation expectations for 2015 were the lowest since records began. Michael Saunders, chief UK economist at Citi, said the market drop had led to a ‘lower sense among employers and employees of what is a normal pay rise.’

Both Deutsch Bank and Barclays expect the Euro to reach parity against the dollar by the end of next year as monetary policy in the US and Eurozone continue to diverge. Mr. Harvey said political risks linked to Britain’s referendum on EU membership, which is due before the end of 2017, could make financing Britain’s ‘very wide current account deficit which stood at 3.7% of GDP in the third quarter, difficult. Deutsch Bank expects the single currency to “grind higher” against the pound over the next few years as a result.’

The future does not look as rosy as our government leads us to believe. We spend money as if there is no tomorrow, we engage in a costly war in Syria and we send 1 billion pounds in aid to the world’s most corrupt nations. Our politicians live in a different world where it seems we can go it alone, and prosper as if the empire is still part of our body politic.

And worst of all, with severe cuts in our defence budget, we hallucinate about our might to fend off our enemies and defend the realm. It’s time we grew up and embraced reality.

It is then that Great Britain will prosper, and recover some of its past glories.

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