Currency Update
If you think Sterling has had a tough time in the last couple of months look what happened in 1992. Do the words "black Wednesday" ring any bells? On 16 September of that year Britain’s Conservative government abandoned its attempt to keep Sterling in the European Union’s Exchange Rate Mechanism. In the space of three months the Pound fell from $2 to $1.50. What we are seeing at the moment is nothing like as bad as that, though it’s bad enough if you’re paid in Sterling.
They were worried about inflation back in the late eighties and early nineties; that is why Britain tried to attach itself to the low-inflation German Mark even at the cost of high interest rates and recession. They (and that means every government and central bank in the world) are worried about it now, for different reasons. Higher interest rates won’t bring down the price of oil. Even less will they bring food prices under control.
They do however make people think, especially if they need to borrow money to do things: Do I need that business meeting in the Far East? That 17mpg Chelsea tractor? More to the point, central banks normally have only one tool at their disposal to keep inflation on target: interest rates. But they are not stupid. Oil is not going to $300 a barrel because demand would quickly dry up. UK house prices will carry on down because they went up too far and to fast. Lower interest rates will make only marginal difference to either situation.
If this all sounds defeatist and pessimistic, bear in mind it is exactly the message we are hearing from the Bank of England. As ever, there’s good news and bad news: Inflation will peak before too long and Britain will – technically at least – go into economic recession.
So what will this mean for Sterling against the Dollar?
There, sadly, it looks at the moment like bad news and bad news. After seven years of decline the Dollar was overdue for a break and at last it’s got one. Having plunged to 2 per cent earlier this year US interest rates will not – barring economic disasters – go any lower. The question is when they will go up. UK rates ticked down to 5 per cent in April and – barring inflation disasters – they are not going up. The question is how long it will be before they go down. The alternatives for currency investors are clear: Get aboard the Dollar as it extends its recovery or stick with the Pound on its way down.
These things are never as cut and dried as they appear. It would be no surprise to see a correction to the Dollar’s recent run of good fortune but that would not necessarily change the fundamental view. If the US economy really has turned the corner, as suggested by the consumer sentiment surveys, and if the UK economy really is heading for hell in the Old Lady’s hypothetical hand-basket, the Pound has further to fall against the Dollar.
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