I must confess I am getting a little worried, Readers will be aware that we have been calling for a stronger pound since mid 2013 and forecasting a test of .8000 by Q1 2014. So what has me worried? The fact that every scribbler and trader now agrees with me! All are forecasting a weaker Eur as Euroland continues to underperform while the US and the UK economies enjoy better than forecast growth.
In 2013 the UK experienced the best year for the economy since the beginning of the great recession in 2007 employment is rising, unemployment is falling, the economy is growing again (at a reasonable pace) and house prices are rising. The forward looking PMIs are all indicating continued expansion in 2014.
So what could possibly go wrong?
A number of things actually but two in particular are worthy of consideration.
The services PMI for November & December have come off October highs and missed market expectations. It should be said that at 58.8, which was a six month low, the PMIs are still at high levels but may signify some easing in services growth for 2014. If the trend lower was to accelerate in January, it may cause some to question the strength of the UK recovery and the rational for holding Stg.
It is also worth watching the unemployment rate which in December fell from 7.7% to 7.4%, the lowest rate since April 2009. While this startling drop in the numbers out of work was welcomed by all and saw Stg strengthen against the majors, it does present a dilemma for Mr Carney and the MPC. It calls into question the validity of the Bank’s forward guidance which has as one of its key parameters a 7% unemployment threshold.
Last summer the Bank reassured markets that it would not consider raising interest rates until unemployment fell to 7%. They forecasted this to happen in the third quarter of 2016. Since then in response to the strengthening economy they have brought forward this strike date to Q3 2015. This forecast is still at odds with the Market which expects the 7% threshold to be hit in 2014.
This leaves the Bank with two alternatives. The first, fall back on semantics, emphasising that 7% is a threshold not a target and low inflation and a strong pound mean that interest rates can stay low for longer. The second is to move the threshold to 6.5%. Doing so carries credibility risks for the Bank and may cause some to question their inflation fighting credentials (despite CPI falling to 2.1% in November). Short term this may be seen as Stg negative and convince many investors (that bought Stg in H2 2013 because they believed a strengthening UK economy would see the Bank of England raising interest rates sooner rather than later) to sell the pound.
What does all this mean for Stg in Q1?
I suspect it means a choppy first quarter. In truth the UK economic releases and sentiment indicators in H2 2013 have been almost universally positive so I am a little disappointed that Stg hasn’t strengthened more. It would have been no great surprise if we had tested .8000 in Q3, that we didn’t tells me that a lot of good (economic) news is already in the price (we trade around .8300 as I write).
The Market I believe will test the downside of Eur/Gbp in early 2014. However expect a fear that all good (economic) news must come to an end and back to my worry bead – everybody thinks Stg is going to strengthen to bring out the profit takers if we see a test of the strong support at .8150/65. If we get through that support then .8000 becomes a feasible target for Stg bulls but in my opinion Stg should struggle to make further progress (sub .8000) in H1.
If you are a Stg buyer then I think you have to take advantage of any rallies that result from negative economic releases or the Bank of England moving its unemployment threshold. Initial resistance is at .8420 and if that gives way we believe the .8500 to .8565 zone offers good value to Stg buyers.
These are my thoughts on Eur/Stg in H1 2014, I would love to hear yours. Please use the comment box below to express your views on the currency.