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King Crushing Pound As U.k. "can’t Afford" Strength

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King Crushing Pound as U.K. ‘Can’t Afford’ Strength (Update4)

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By Anna Rascouet and Lukanyo Mnyanda

Aug. 17 (Bloomberg) -- The pound’s biggest five-month rally in 24 years is ending as the Bank of England floods the shrinking U.K. economy with newly printed cash and slowing inflation precludes higher interest rates to lure investors.

The currency soared 23.5 percent from March 10 to Aug. 5 on speculation U.K. assets would rise as the worst financial crisis in six decades eased. The sharpest increase since 1985 ended Aug. 6 after policy makers said the recession was deeper than anticipated and moved to spur the economy by expanding its purchases of U.K. debt 40 percent to $290 billion. Six days later, central bank Governor Mervyn King said inflation will probably fall below the Bank of England’s target.

The pound has slumped 2.6 percent since Aug. 5 to last week’s $1.6543 close. Only three of 176 currencies tracked by Bloomberg did worse. BNP Paribas SA, France’s largest bank, predicted another 9.3 percent decline to $1.50 in 12 months. Bank of Tokyo-Mitsubishi UFJ Ltd. said the currency is near a “tipping point.†After the Bank of England decision, pound futures and options speculators became more pessimistic as weekly bets favoring sterling fell more than 32 percent, the most since November.

“I’m super-bearish on the pound,†said Hans-Guenter Redeker, the London-based global head of foreign-exchange strategy for BNP. “The Bank of England has made it clear it can’t afford a stronger currency.â€

Borrow, Spend, Print

Weighing against the pound are attempts by Labour Party Prime Minister Gordon Brown and King to revive growth with increased borrowing, deficit spending and money printing. The U.K. will sell a record 220 billion pounds ($363 billion) of debt in the year ending March 2010, the government said April 22, prompting Standard & Poor’s a month later to warn that Britain may lose its AAA credit rating.

The U.K. economy shrank 5.6 percent in the second quarter from a year ago, faring worse in the deepest global downturn since World War II than the U.S. and the 16-country euro zone, which declined 3.9 percent and 4.6 percent, respectively.

Median estimates in Bloomberg economist surveys see the U.S. shrinking 2.6 percent in 2009 and expanding 2.2 percent in 2010, compared with a 4.1 percent contraction followed by 0.9 percent growth in the U.K. The euro economy will fall 4.3 percent this year and rise 0.5 percent next, survey medians predict.

Six days after the Bank of England ramped up its so-called quantitative-easing program of debt purchases, the U.S. Federal Reserve said it was winding down similar plans as it shifts focus from economic recovery to inflation control.

‘Ugly for a While’

“The fundamentals in the U.K. are certainly not pretty,†said John Taylor, who oversees $9.5 billion as chief executive officer of FX Concepts LLC, a New York hedge fund. “It’s a race for the least ugly of the candidates, and I would argue that the U.S. is going to be the least ugly for a while.â€

The pound is likely to strengthen no more than 5 cents before “getting crushed†in September, October and November to as low as $1.45, Taylor said. The median prediction in a Bloomberg survey for the first quarter of 2010 fell 3 cents to $1.64 per pound following the Bank of England announcement. The forecast rebounded back to $1.67 on Aug. 14.

The pound declined for a second day against the dollar, falling 1.3 percent to $1.6335 as of 5:57 p.m. in London, after Rightmove Plc said U.K. home sellers lowered asking prices in August by the most in eight months.

Some investors are betting the pound rally will continue as measures by Brown, 58, and King, 61, ease the economic slump. London-based HSBC Holdings Plc, Europe’s largest bank, predicts the currency will rise to $1.75 by the end of 2010.

Smallest Margin

The housing market already shows signs of improvement. Lloyds Banking Group Plc’s Halifax division on Aug. 5 said U.K. home prices rose 1.1 percent last month, almost twice as much as the median forecast in a Bloomberg survey. Real-estate agents and surveyors reporting price drops outnumbered those reporting gains by the smallest margin in two years, according to a poll released Aug. 11 by the Royal Institution of Chartered Surveyors.

The expansion of the quantitative-easing program “seems like an insurance policy on the back of the weak second-quarter GDP numbers, and our view is for further appreciation†of the pound, said Paul Mackel, a director of currency strategy at HSBC in London. “The need for tightening monetary policy in the U.K. will become more apparent faster and that will become the pillar point for sterling to start re-establishing a more solid path versus the dollar.â€

Tracking Stocks

Goldman Sachs Group Inc. said pound traders already have taken into account signs of recovery. “After a sizeable appreciation, the pound has now priced in this improvement,†analysts led by Dominic Wilson at the New York bank said in their monthly foreign-exchange report for July.

After spending most of the 1990s under $1.70, the pound started to climb in mid-2001 as the Standard & Poor’s 500 Index of U.S. stocks plummeted following the crash in technology shares. From there, it mostly tracked the S&P 500, hitting a 27- year high of $2.12 on Nov. 9, 2007, a month after the stock gauge’s record 1,565.15 close.

The seizure of credit markets that had spread to the U.K. by early 2008 claimed its first victim that February when Brown was forced to nationalize Northern Rock Plc after Britain’s first run on a bank in more than a century. The U.K. economy began shrinking the next quarter.

Behind in Polls

The pound topped $2 for the last time on July 23, 2008, and tumbled after September’s collapse of Lehman Brothers Holdings Inc. triggered the worst lending freeze since the Great Depression, pushing investors toward the perceived safety of the dollar. The pound closed at $1.38 on March 10, the lowest level since June 12, 2001, down almost 35 percent from its 2007 high. That was the day after the S&P 500 began its steepest five-month climb since the 1930s, gaining more than 48 percent as of Aug. 14’s close.

The subsequent pound rally lasted even as the U.K. economy shrank 2.4 percent in the first quarter, the most since 1958, and 0.8 percent in the second, twice the median of Bloomberg’s survey of economists. The number of unemployed Britons reached the highest level since 1995 in the second quarter. With the next election now less than a year away, Labour has trailed the Conservative opposition in polls since 2007.

Then came the Bank of England’s unexpected move Aug. 6 to increase its purchases of U.K. gilts by 50 billion pounds to 175 billion pounds, a move aimed at supporting debt prices to push down yields, the benchmarks for borrowing rates paid by businesses and consumers.

Betting on Rates

The U.K.’s recession “appears to have been deeper than previously thought,†the bank said. Six days later, King said it’s “more likely than not†that inflation in Europe’s second- largest economy will fall more than a percentage point below the bank’s 2 percent target.

That halted the pound’s rally as investors increased bets that King wouldn’t raise the central bank’s benchmark interest rate next year from its record low of 0.5 percent, where it has been since March 5. Prices rose for futures contracts betting that the rate will remain flat in March 2010, reducing the yield to 1.18 percent on Aug. 14, the lowest level since at least March 2005 and down from 1.64 percent the day before the Bank of England expanded its quantitative-easing program.

As for the Fed’s benchmark rate, near zero since December, futures on the Chicago Board of Trade show a 65 percent chance the U.S. central bank will raise it at least a quarter-point at its March 2010 meeting.

More Bearish

“The market was expecting the BOE to be one of the first to hike rates,†said Lee Hardman, a currency economist at Bank of Tokyo-Mitsubishi in London. “It’s becoming clear that’s unlikely, undermining the pound.â€

In the week ended Aug. 11, after the Bank of England’s decision, hedge fund managers and other large speculators had 25,074 options and futures that profit if the pound strengthens, known as long contracts, down 11,984 from the week before, data from the U.S. Commodity Futures Trading Commission show. That’s the sharpest decrease since Nov. 11.

With fewer long futures and options outstanding than short ones, the ratio of speculators’ bets it will rise over wagers it will fall was 0.889, down from 0.999 the week ended Aug. 4.

Goldman Sachs, which in May predicted the pound would gain 23 percent against the dollar and 15 percent against the euro by the end of the year, has lowered its forecasts, citing “worries about the fiscal outlook and the potential need to cut expenditure.†The pound, which closed last week at 85.94 pence per euro, will trade at 84 pence from this year’s third quarter of 2009 through 2010’s second quarter, the bank predicted.

‘Over-Priced’

Chancellor of the Exchequer Alistair Darling said on April 22 that this year’s budget deficit would reach 175 billion pounds, or 12.4 percent of gross domestic product, the most since World War II. The median forecast of 15 economists in a Bloomberg survey foresees the deficit swelling to 600 million pounds in July, following a 5.2 billion-pound surplus a year ago.

Standard & Poor’s, which has lowered its outlook on the U.K.’s top AAA credit rating to “negative,†said government debts could double to almost 100 percent of GDP by 2013.

“Sterling is over-priced at current levels†said Geoff Kendrick, a currency strategist in London at UBS AG, listed by Euromoney Institutional Investor Plc as the world’s second- biggest currency trader.

“The BOE have made it clear they are more concerned about deflation, and it’s possible they might do more quantitative easing,†Kendrick said. “The economy is still soggy.â€

http://www.bloomberg.com/apps/news?pid=206...id=avULD0BWfzPM

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I think the colours are only used at the extremes.

So white means companies that made no profit/no loss?

AIG looks mega-f*cked.

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