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The UK economy gained speed and eventually, sterling made new highs. The UK economy advanced 0.3 pct on quarter in the three months to June of 2017, unrevised from the preliminary estimate and following a 0.2 pct expansion in the previous period. There was relatively strong growth in government spending and investment, while household consumption rose at softer pace and business investment stalled.
Currently, in real trade weighted terms, sterling is about 15% below the average of the last 25 years. It has just bounced off its lowest level, which was about 10% weaker than the level it reached after the pound’s exit from the ERM in September 1992. In terms of the size of the fall for the pound, neither the 1992 collapse nor the 2016 one is as big a fall as we saw in 2008/2009, when the global financial crisis hit, but the basic script is the same. Collapse, consolidation and eventually, recovery.
1992 saw EURGBP, inferred from GBPDEM, rise from around 0.70 to 0.86 in 1993. GBPUSD fell from 2.01 to a low at 1.41. The pound’s fall since early 2015 has seen EURGBP rise from 0.70 to 0.90, in the broadest possible terms. And GBPUSD has fallen from a peak above 1.70 in 2014 to a low below 1.20.
That leaves sterling nearly 10% undervalued against the dollar on a PPP basis, but not very undervalued against the euro. Low levels of gilt yields remain an anchor on sterling. EURGBP’s recent correction looks very warranted and the GBPUSD bounce looks very sensible. But thinking about yields also highlights the key to the sterling outlook.
As the European economy recovers, and the ECB edges towards tapering, can the MPC help sterling unless the economy gains momentum enough to warrant not just a one-off reversal of last year’s rate cut, but expectations of a series of moves? Likewise, though the US economic cycle is, like the UK’s, past its peak, how far can UK yields rise relative to US ones if Treasury yields edge higher in their range, if the Fed goes on tightening carefully and if there is a fiscal response to Harvey and Irma.
