The Pound Takes the Fall for the Slowing U.K. Economy

Joined : 23 Dec 2007 Posts : 241 Location : Nigeria

Greetings Currency Traders!

Over the last few weeks it seems the idea about a weakening U.K. economy is gaining traction. Answers to this ongoing credit crisis are few and far between. The question marks still take up most of the news headlines.

The result: the British pound is tripping over itself Sad

.

Take a look at a couple of the headlines from Bloomberg earlier this week:

U.S. November Existing-Home Sales Rise 0.4% to 5 Million Pace
Defaults on privately insured U.S. mortgages rose 35% in November from the same month last year, an industry report showed, adding to evidence the U.S. housing slump is deepening.
The pound posted its first annual drop in three years against the euro on speculation the Bank of England will keep cutting interest rates while the European Central Bank stays on hold.
London Scottish Bank Plc, the U.K. lender to customers with poor credit histories, fell the most in a decade in London trading after saying it will take a charge of as much as 22 million pounds (US$44 million) to cover losses.

Why the Pound Finished in the Red Against the Euro
The British pound finished in the red versus the euro this year. It's the first time in three years that has happened. The big reason: a narrowing yield advantage. The Bank of England (BOE) benchmark rates are expected to drift lower while European Central Bank (ECB) benchmark rates are expected to stay the same.

Why? Because the BOE will have to use a more accommodative monetary policy this year to combat the rising inflation and growth. It's not clear yet if the Eurozone will face comparable pressures.

Case in point: Another U.K. lender is feeling the pain. This time it's London Scottish Bank Plc's turn to suffer. The company lends to customers with poor credit history and a report released earlier this week revealed the lender is expected to take a charge of roughly US$44 million to cover losses in this arena.

Now combine that with a whiff of dollar-positive news and SMACK...a rough day for the pound (granted the rest of the pack is suffering at the hand of the almighty greenback, too.)

Looks like dollar bears might be reaching for the leftover champagne today to help dull the pain!

Happy New Year!

Jack Crooks, Editor of
World Currency Options

Making 'Cents' of the Headlines
Bad News Rocks the U.S. Markets This Wednesday

What Happened:
On Wednesday, the private research group, the Institute for Supply Management (ISM) released the U.S. manufacturing numbers for December.

Long story short: It was NOT good news for manufacturing, and it made the U.S. dollar plunge today.

According to the Institute, December's manufacturing number was 47.7. Any ISM number below 50 shows that manufacturing is contracting in the United States, so this number was less than inspiring for the U.S. manufacturing sector.

To produce the index, the research group surveys purchasing managers on employment, production, new orders, supplier deliveries, and inventories. Traders watch these surveys closely because purchasing managers, by virtue of their jobs, have early access to data about their company's performance, which can be a leading indicator of overall economic performance.

How the Markets Reacted:
The number was expected to come out at 50.5 vs. 50.8 previously. The unexpected 47.7 caused the U.S. dollar to plunge against both the euro and Swiss franc very sharply.

This announcement not only thrashed the U.S. dollar but also stocks. The Dow plunged over 100 points upon the announcement.

What I Say :
It's not a huge surprise to me, because lately the heads of the major transportation companies have been giving negative comments to their analysts. They've been noting a slow down in manufacturing and shipping. In fact, many of these stocks are struggling. FedEx is hitting a 52-week low right now and UPS is not far behind them.

You don't have a crashing stock price unless something is wrong and something is very wrong in America's economy right now (as the ISM number reflected).

So how will this affect currencies?

A negative U.S. economic number means turmoil and risk is still whipping through the world's markets. When risk hits the markets, traders drop their riskier carry-trades for safer assets. So look for carry-traders to dump their carry-trade positions like EUR/JPY, GBP/JPY, EUR/CHF and GBP/CHF which in effect is buying the yen and the Swiss franc.

Today the U.S. dollar is suffering on this news, but I believe it's only temporary. The worst news has already been priced into the buck. And when carry-trades run for safer assets, they'll also eventually reach the dollar. That should cause a short-term boost for the buck later this year. However, carry trades will take the brunt of the fall.