Sterling has been able to hold its position against the Euro for much of the period since 1999 with overvaluation in comparison with the German economy offset by the fact that the Euro had been persistently dragged lower by weakness in other key countries. Sterling, however, is now near 8-year lows as Brexit fears have undermined confidence in the UK outlook.
Overall Sterling sentiment has continued to weaken in 2017 with the UK government’s inability to secure a majority in the General Election increasing fears of instability and also making it even more difficult to secure a satisfactory outcome to the Brexit negotiations.
Selling pressure on Sterling was intensified by a strong Euro recovery as stronger growth rates triggered expectations of an ECB move to tighten monetary policy.
June 23rd 2016 – 2017: Brexit represents another UK shock
The relative balance of forces changed substantially following the June 23rd UK referendum on whether to remain in the EU.
There had been very limited expectations that the UK could vote to exit the EU and the leave result triggered a substantial market shock.
There were increased fears surrounding the long-term UK outlook with concerns that underlying growth rates would be substantially weaker over the medium term.
The Bank of England also cut interest rates once again to 0.25% which undermined Sterling confidence. The inconclusive June 2017 election increased fears over political instability and there were expectations of difficult negotiations with the EU.
2014 – June 22nd 2016: Euro weakness dominates
During this period, there were further concerns surrounding the Euro-zone outlook as governments and the ECB were unable to find a permanent solution to the crisis. The debt crisis continued to flare-up with another bailout for Greece while the Euro was trapped in permanent low growth with further speculation that the Euro would break up.
As confidence in the Euro-zone and Euro continued to weaken, ECB President Draghi announced that he would do whatever it takes to protect the Euro. Draghi was successful in preventing a break-up of the Euro area.
The ECB, however, was forced to cut interest rates very aggressively in an attempt to meet its inflation target and ease financial tensions. The move to zero interest rates and a negative deposit rate, together with the quantitative easing programme, pushed the Euro sharply lower against all major currencies. Sterling was, therefore, able to make headway as EUR/GBP retreated to the 0.7000 area despite very low UK interest rates.
2011 – 2014: UK recovery, Euro-zone crisis
The UK economy gradually emerged from recession with a return to growth and there was a steady recovery in the banking sector.
At the same time as a gradual UK recovery, confidence in the Euro-zone outlook deteriorated sharply.
The Euro-zone had been pushed into recession during the global banking crisis and, although fears surrounding the banking sector were slower to emerge, fears escalated during this period.
The Greek debt crisis also emerged for the first time in 2010 with the Euro-zone members effectively forced to bailout Greece in order to prevent a serious collapse within the Euro-zone banking sector.
Governments found it very difficult to control the debt crisis and the Euro-zone as a whole lurched from crisis to crisis with persistent fears over a sovereign debt crisis.
The tables were, therefore, turned in global currency markets with the Euro under sustained selling pressure while there was a net recovery in Sterling with EUR/GBP declining to the 0.8000 area.
2008 – 2011: global financial crisis, UK banks badly damaged
The first real evidence of the great financial crisis emerged in August 2017 with redemptions halted in two property funds.
The immediate UK impact was limited, but stresses quickly emerged in the money markets as wholesale lending started to seize up. Given that there had been an increased dependence on money-market lending by UK financial institutions, confidence in the sector quickly declined and financial difficulties emerged.
The initial focus was on Northern Rock which requested government support in November 2017. The crisis intensified rapidly in early 2008 with Northern Rock nationalised. The UK suffered a wider banking-sector crisis as Lloyds Bank and the Royal Bank of Scotland required government support to avoid collapse.
The banking crisis was an important factor in pushing the UK economy into a deep recession and the Bank of England was forced to cut interest rates very aggressively to stabilise financial conditions.
Although the banking crisis was a global feature, the UK banking crisis was a key factor in triggering heavy selling pressure on Sterling as EUR/GBP peaked at record highs around 0.9800.
2003 – 2007: the great moderation, false UK optimism
At the time, the period between 2003 and 2008 was marked by an optimistic period for the UK economy. Under the Blair government, government finances were boosted by strength in tax revenue and deficits appeared to be under control in historic terms.
The Bank of England Monetary Policy Committee remained successful in controlling inflation which held close to the 2% target and there were no serious concerns surrounding the balance of payments. Overall GDP growth also maintained a firm tone which helped underpin Sterling sentiment.
With hindsight, the macro-economic policy framework was building up excessive debt amid lax regulation and compounded by excessive global debt expansion, although these concerns were relatively limited at the time.
Jan 1st 1999 – 2003: Euro teething troubles
The Bank of England was granted independence to set interest rates following the 1997 general election and by the time of the Euro’s introduction in 1999, the framework was well established.
The Euro was unable to make headway following its 1999 launch and the single currency weakened sharply to lows below 0.8500 against the dollar in 2000 with an underlying lack of confidence in cohesion for the new currency. EUR/GBP hit a low below 0.5700 in early 2000.
Sterling was able to recover after the 2008 financial crisis as Euro-zone fears dominated, but has now weakened to similar levels with expectations of permanent damage to the UK economy if there is a disorderly EU exit.
We believe the most likely outcome is that indeed the UK will exit the EU in a non-organised matter, resulting in a severe dent to economy, and the pound slipping to the level of parity with the Euro by end of 2018.
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