What will happen to GBP is 2011?
Currency UK Foreign Exchange outlook for 2011
The foreign exchange market can be a tangled web of mixed messages at times, so we have prepared this article in order to outline some of the possible events and outcomes most likely to move the foreign exchange market throughout 2011. None of the models developed so far succeed in predicting FX rates in the longer time frames, therefore long term currency forecasts generally turn out to be inaccurate. It is possible however to gain a better understanding of how what you read in the news is likely to effect the currencies you are interested in.
Three general themes are set to influence foreign exchange news in 2011:
(1) Fiscal payback/Austerity - Governments trying to increase tax revenues whilst reducing expenditure.
Fiscal policy was the defining issue for global markets in the first half of 2010. It receded in Q3 as Europe delivered – and the UK promised – unprecedented fiscal tightening then returned in Q4 to drive the European periphery with Ireland. While European fiscal stress had much less impact on global currency markets in Q4 than earlier in 2010, it is premature to write off the issue in currency markets. Generally speaking, if a government has delivered (or promised) significant cutbacks, their currency has strengthened - a sign that the FX markets like cautious governments.
(2) Central bank rates versus real risks in their economies - Central banks need to keep interest rates low to keep spurring growth but this could be negative for inflation. High inflation is deemed negative as it literally means people are uncertain of the value of their money in a year’s time and hence save instead of spend.
(3) USD deficit issues (global rebalancing) - This is an old topic and was really last in the news in a significant way back in early 2008 when we had the amazing rate of 2 dollars to the pound. This is set to hit the news again. The US could approve another Homeland Investment Act to encourage American corporations to bring their profits back to the US. Why is this such as issue? The USD is the international currency of choice and many of the world’s biggest companies ultimately report their profits in USD – If these companies have huge profits sitting in EUR and these funds are repatriated back to USD – then this means selling the EUR and buying the USD, which is likely to weaken the EUR and as such improve GBP’s performance against the EUR. Ultimately the most affected currency would be the EUR (Apparently 40% of US funds held abroad are in EUR) followed by GBP.
Past weeks have seen EUR weaken with concerns over European debt, similarly GBP found some strength as no further QE (Quantitative Easing) measures have been announced. Looking into 2011, many economists expect the UK economy to recover with the inflexibility of the single currency likely to hinder the Eurozone economy as a whole. This could lead to an improvement in the GBP/EUR exchange rate. However there are significant risks to this expectation:
Will the UK government spending cuts which were viewed positively by the FX markets, hinder economic growth in 2011 and hence weaken GBP?
Will the Bank of England inject more cash into the system to encourage lending and growth (Quantitative Easing) which could weaken GBP?
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: GBP/EUR 1.1365 – 1.2350
Recent focuses on the debt issues of Ireland and now Portugal, Spain and Italy have artificially strengthened the USD as institutional investors buy USD to reduce their currency exposure risk (this is when the USD is called a safe haven currency). But whether USD weakens further in 2011 depends on Federal Reserve policy more than debt concerns here in Europe.
We have seen the Pound actually make reasonable gains against the US Dollar over the past few weeks as the Federal Reserve finally decided to introduce further QE which led to the Dollar losing ground against a major currencies – This is great news for those of you looking to buy Dollars. However beware, a common saying on the currency market is that when the U.S sneezes the U.K catches a cold so and having already been mentioned on numerous occasions it may be just around the corner that the U.K and the Pound follows suit and loses value.
The British Pound is the least overvalued of the majors against the US Dollar, with the currency 9.7 percent above its PPP-implied exchange rate. This is a far cry from the extremes noted in the Euro and the Swiss Franc, suggesting Sterling may have some room to play catch-up. The Bank of England is surely keen to prevent a slide back into recession as the Government’s ambitious austerity programme takes its toll on economic growth, So renewed stimulus is certainly a possibility down the road. On balance, the bias is bearish from a pure valuation-based perspective but we think it prudent to wait for the time being until a more attractive selling opportunity presents itself.What is Purchasing Power Parity? CLICK here to find out
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: GBP/USD 1.6500-1.9000
The Pound has been extremely turbulent against the Swiss Franc dropping to record lows a few weeks ago and then turning around in a matter of days last week. This rate is going to be very dependent on confidence in the UK, as the Swiss Franc is very much seen as a safe haven currency. When confidence is low. investors will buy the Swiss Franc, therefore increasing demand and making the Franc more expensive to purchase and when confidence rises in the U.K and indeed globally we generally see the reverse.
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: GBP/CHF 1.48 -1.64
The euro has already fallen more than is typical during fiscal consolidation, whereas the dollar’s decline has
barely begun. This does not take into account the European debt issues. As such expect a turbulent 2011 as EUR debt issues versus inevitable USD decline cause a large and volatile trading range.
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: EUR/USD 1.15-1.48
China’s slowdown is the perennial fear, but Australia is also a candidate given the impact of higher rates
and a strong currency on monetary conditions this year. “There are decent risks of a late-cycle rotation within the commodity bloc, whereby AUD’s outperformance fades as the RBA ends its tightening cycle”. In either case given the mere fact that Australia has had an amazing run probably means that sooner or later that run will come to an end. However for the time being the trend is definitely in favour of AUD – so if you are looking to buy AUD before mid-2011 then perhaps consider buying sooner rather than later.
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: GBP/AUD 1.4920 – 1.7350
For the time being NZD is likely to outperform GBP and stay strong into the middle of 2011 however with expectations of GBP strength materialising in late 2011 we could see some unfamiliar rates towards the end of the year – as ever ‘expert’ forecasts vary considerably.
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011 : GBP/NZD 1.9500 – 2.3550
ZAR is generally expected to continue its slow appreciation throughout 2011 mixed with some severe swings and cycles related to commodity prices and political sentiment.
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: GBP/ZAR 10.3000 – 12.9000
CAD could be set to improve further throughout 2011 as the central bank look amongst the closest to raising their interest rates further (which attracts more buyers to a currency and strengthens it). This means if you are buying CAD it is likely to get worse the longer you leave it.
RANGE OF FORECASTS FROM MAJOR INVESTMENT BANKS FOR END OF 2011: GBP/CAD 1.4850 – 1.6600
This article does NOT represent a recommendation to buy or sell any particular currency and has only been compiled in order to provide our current and prospective customers a generalised view of the foreign exchange market.
Recipients and readers should not rely on the contents of the documentation and should make their own independent assessment as to the accuracy and suitability of the information.
Nothing contained in this document or any other information or explanation provided by Currency UK will be considered an invitation to engage in business, a recommendation, guidance, proposal, advice or solicitation to provide investment, financial or banking services or an invitation to engage in business or invest or deal in any financial instruments.
