Last year, we heard a great deal about the euro, a fair bit about the dollar, and plenty of rumblings about the renminbi (or the ‘redback’ as China’s currency is starting to be known).
But for British investors, what really matters is the pound. So what’s 2011 likely to hold for sterling?
Over the last year or so, the pound's thing that drove the pound was politics. And it looks very much like the same will happen again this year…
Sterling is looking queasy
Back in May, 2010, in the aftermath of the general election, sterling looked distinctly queasy. We had a hung parliament and nobody was quite sure what would happen next.
On May 10th, Gordon Brown stood down as prime minister. Under his stewardship the pound had lost almost 30% of its purchasing power, going from over $2.00 to $1.48 against the dollar. But even after his departure the pound continued to sell off, eventually reaching $1.43 a week later.
Then came David Cameron and Nick Clegg’s show of unity. “Cuts” and “austerity” became the new buzz words. The forex markets liked what they saw. Over the next six months, the pound rallied by almost 14%.
But since November, with the university fees issue bringing matters to a head, the LibDem side of coalition has started to wobble. Meanwhile, some very nasty numbers about our debts and deficits were announced. And now the pound is taking on that distinctly queasy look once again.
What's happened to the pound?
So what next? First, let’s take a look at a chart of the pound against the US dollar over the last two years or so, with some annotations from me:
It’s clear that the pound’s fortunes rise and fall with the stability of what is effectively its main issuer and controlling interest - the UK government. Forex traders don’t like the uncertainty that surrounds weak government.
With the coalition now looking wobbly – and the more negative pundits even suggesting it won’t survive 2011 - we find ourselves in a short-term downtrend, which began two months ago. It looks set to continue until these issues – in which so many coalition policies are deemed to be at odds with pre-election LibDem pledges – resolve themselves one way or the other. I daresay that will take a few months at least.
Meanwhile, the execution of some of the tougher Tory rhetoric – the cap on housing benefit for example – has been deferred, which suggests the government is not as strong as it once appeared. That will not help the pound either.
Take a look at a five-year chart of the pound against the euro (first chart below), and, beneath that, the pound vs the dollar (green line on the second chart). While the short-term gyrations differ according to which state is currently deemed to have the greater problems, the US or Europe, in the longer term the trend is similar.
The pound capitulated in 2007 and 2008. In 2009 and 2010, some kind of basing pattern seems to be in progress, as marked by the blue lines.
For all the eurozone’s problems, you might have expected the pound’s performance against the euro to be rather better. But, on the plus side, the lows of 2010 were higher than the lows of 2009, which in turn were higher than the lows of 2008. So an upward trend of sorts seems to be in progress, though it’s hardly what you’d call parabolic.
The future for sterling
At a lunch back in November I was asked to make a prediction about the pound and I’m happy to revisit that here. Overall, it’s impossible to be wildly bullish about the pound, given everything, and I’m negative in the short term. But in the longer run I’m not as negative as some. That’s in comparison to other fiat currencies, of course.
Over the next year or so I expect the pound to trade in a range against the dollar with the high .40s marking the low side (the blue trend line holds) and the mid-to-high .60s marking the top side. Given the government’s current problems, a trip to the lower end of the range, and perhaps a little kiss of the blue line, looks likely before any visit to the higher echelons.
It’s a similar story with the euro. I see a move to €1.13-4, which I would expect to hold, before a rally up to the €1.25 area.
But here’s the slightly troubling thing. The euro and the dollar have been among the weaker currencies. Against the Canadian and Aussie dollars, for example, and the Japanese yen, the pound has been absolutely woeful. So even if the above gentle uptrend remains intact, I daresay it will be quite some time before foreign destinations start to look cheap to UK travellers once again.
This article first appeared in Money Morning, the free daily investment email from UK investment magazine, Moneyweek. Sign up here - it's free.
