IIt’s been another hectic year for the pound, but surprisingly it looks set to end the year not too far from where it started.
We ended 2019 near the highs of the year in the aftermath of a landslide general election victory for the outgoing Conservative Party. As a result, the Conservatives were finally able to push through the UK’s exit from the European Union on January 31, 2020 and enter the transition period which expires at the end of this month.
After a reasonable start to the year, the new government’s honeymoon period proved somewhat short-lived as the slowing economy prompted speculation that the Bank of England could cut rates further. 0.75% at the start of the year. Reports of a virus spreading across China and parts of Asia also raised concerns about a possible global pandemic by the end of January.
The Pound has also had to contend with some political instability, as divisions at the top of the government saw the departure of Sajid Javid as chancellor, to be replaced by rising star Rishi Sunak, who now appears to be the frontrunner for replace Boris. Johnson, if he were to resign as Prime Minister.
The pandemic moves towards the US dollar
Between the middle and the end of February, it was slowly becoming apparent that concerns about a global pandemic were starting to become a reality, after Italy reported a sharp increase in coronavirus cases and deaths, and the turmoil The resulting market pressure began to cause a flight to the safe haven of the US dollar.
As the dollar’s strength weighed on the pound, sentiment around an EU-UK trade deal was also starting to crack, after Prime Minister Johnson told the EU he would not walk away without a deal if the EU did not show up. a Canadian-style trade deal. This position once again signaled the quite predictable return of warnings of a possible slide towards parity with the euro and the US dollar. As stated a number of times over the past few years, while there may be a series of plausible scenarios for an outcome like this, none of them are really grounded in reality.
Even taking into account choppy politics, currency movements are rarely a zero-sum game, and although we have heard a number of claims that the Pound trades like an emerging market currency; it really doesn’t, doesn’t and doesn’t. It was trading much more volatile in the late 1980s and early 1990s, long before the euro even became a currency, and remains one of the most liquid currency pairs in the forex markets. .
GBP / USD hits lowest level in 35 years
There was a sharp drop in the pound to its 35-year low against the US dollar in March, but that was not because of concerns over an EU-UK trade deal, but because of ” a sudden global shutdown of the stock markets prices and just about everything else fell out of bed on an historic scale, as politicians around the world embarked on a massive fiscal stimulus package to avert a financial and economic crisis .
Not only did the Bank of England cut rates twice in March, first by 50 basis points, from 0.75% to 0.25%, and then back to the current record low of 0.1%, but it has also increased its bond purchase program from £ 435 billion to its current level. level of £ 875bn, with the latest increase of £ 150bn at the recent November meeting.
For most of this year, the headline rate has remained at 0.1%, with a number of policymakers sending smoke signals about the prospect of further rate cuts into negative territory. The reasoning behind further cuts is that it would help boost consumer spending, as well as investment, and that it was clear that negative rates had worked in the EU and Japan, where rates already sit at these historically low levels.
However, this reasoning is almost laughable, given that banks in both regions cannot even sell these loans and struggle to generate any margin on their lending operations. Whatever these makers are smoking is definitely a strong stuff. Additionally, consumers are highly unlikely to spend if they worry about 1) catching an infectious virus, or 2) losing their jobs due to the massive shutdown of the economy due to lockdowns. .
While the Bank of England has consistently refused to rule out the prospect of a rate move into negative territory, it is slowly becoming clear that the negative effects on UK banks, as well as the UK financial system, have prompted the Bank from England to think about. , and rightly so. The current malaise surrounding the UK economy has nothing to do with the level of interest rates and more to do with the current uncertainty surrounding the pace of the recovery from the pandemic, as well as our future trading relationship with the ‘EU.
What’s next for the pound?
As we look towards 2021, the big question now is what happens next for the pound, and while the outcome of the EU-UK trade talks is likely to be a key driver, it is not. not the only one, with the future direction of Monetary policy of the United States and the ECB should also play a decisive role.
So far, the rebound from the March lows has been steady, and despite a very brief lightning move to 1.1410, the pound closed the month well above the 1.2000 area, and has since continued to return to levels last seen late last year, and may end the year higher against the US dollar.
GBP Performance Chart (2020)
Source: CMC Markets
The pound’s performance was less impressive relative to its other peers, but nonetheless the trend towards a stronger pound continued, and a return to the 1.4000 level against the US dollar remains my preferred option.
Last year I spoke about the importance of the 1.2000 area which was a key pivot level while also reflecting on the importance of the 200 month moving average as well as the importance of reversals. price towards long-term averages.
GBP / USD Monthly Chart 1990-2020
Source: Bloomberg
Some of the more technical analyzes tend to elicit some skepticism from certain quarters, and while there are no absolutes when it comes to talking about price movements, we can still talk about probabilities, based on precedents. After another 12 months of price action, there appear to be signs of a base moving above the 50-month moving average, with the odds that the pound has hit a near-term low seeming more likely, and the prospect of movement towards 1.4000 and then towards the 200-month average over the next 18-24 months.
In 2007 there was a move above 2.05 but it was very short lived with the financial crisis causing a sharp drop. The 2016 lows at 1.1950 saw this pattern repeat itself, rebounding from this key level. At the same time, the 200-month average was worth 1.6500, with a 25% higher move targeting a level above 2.06, while the lows of 2016 and 2017 saw a move briefly below of 1.2000, before a strong rebound to 14,350, then another test of 1.2000, and another subsequent rebound. Both downward moves came about 25% of the 200-month MA spread before rebounding.
If we assume that prices eventually return to their long term average, only one of two things can happen, either the price reverts to the long term average or the average goes down to reach the price, which would take longer. long and suggest a prolonged period of lateral price action. Given the past price behavior, the odds are still favorable for the price to move towards the mean, which has risen from 1.6500 to its current level of 1.5830, and which by the end of the year. next will obviously be lower.
What matters is what the charts indicate, in terms of long term reversals to an average. Over the past 30 years, the pound has never moved more than 25% from its 200-month moving average for an extended period. We can also check the daily charts for other indices in GBP / USD, where there has been an uptrend since May.
GBP / USD daily chart (2020)
Source: CMC Markets
Seen on this basis, it would take a move below the 1.2850 area to undermine the current bullish momentum that has been in place since the end of the second quarter.
Ultimately, the direction of the pound will depend to some extent on a number of factors including future central bank policy, fiscal stimulus as well as the outcome of the EU-UK trade talks. A weaker US dollar will also help generate gains if the new US administration, led by President Biden, takes further action that significantly weakens the US dollar.
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