STERLING POUND STEALS THE SHOW

United Kingdom’s sterling pound, the currency of the world’s 6th largest economy, has sunk by more than 7 per cent since 2014 till date as economic growth has faltered to an estimated 0.3 per cent in Q1 2015, the weakest since 2013, due to unsatisfying manufacturing and service activity, thereby indicating that the economy is growing at a snail's pace. The conditions were not as bad in the earlier part of 2014 when UK’s manufacturing activity was in a great shape mainly due to expansion in output and improved demand from domestic as well as international markets. This boom in manufacturing coupled with robust service sector led to increase in employment activities and wages, eventually leaving the inflation rate to rise within the targeted range of 2 per cent, which was a sign of blooming economy.

According to data generated by IMF, UK has been the only economy that grew faster than any other advanced economy in 2014 at 2.6 per cent year on year; however, it is currently running slower at 2.5 per cent behind the US. Further, a breakdown in crude oil prices in the second half of 2014 was initially positive for the UK’s economy as it is a net importer of oil. Businesses that depended heavily on oil inputs profited more with decrease in cost of production, in turn boosting employment, discretionary income, and investments. However, the CPI reduced considerably and resulted in delay of interest rate hike by the Bank of England.

Moreover, the collapse in crude prices was mainly in response to subdued global demand, leading to surplus crude inventories, in turn hitting the economies of Russia, US and OPEC members. Besides, the euro zone economy softened considerably, leading to deflation that resulted in delay in consumer spending and surging debt, which slowed down the growth rate. Weakness in the euro zone economies will have a spillover effect on the UK economy as it has contributed some amount to the IMF which will be used as bailout funds and some deposits have been made in euro zone banks like France who in turn have lent to Italy and Spain. Any collapse in the euro zone economy will have a spillover effect on the UK, thereby hurting the pound.

As more than 50 per cent of the UK’s total trade is done with the European Union, the manufacturing sector was hurt the most following a drastic fall in demand for output and a plunge in business confidence to an all time low since 2013. The crisis in Greece has been a major cause of concern since any default in payments to its creditors will put the entire euro zone into trouble, thereby directly hitting the demand for goods and services in the UK. However, comments from German Chancellor Angela Merkel that everything must be done to prevent Greece running out of money before it reaches cash-for-reform deal with its international creditors has infused some hope. On the contrary, Greece’s ultimatum to relax the bailout conditions or it would default on a Euro 750 million repayment to the IMF has raised serious concerns over this issue.

Current Scenario

Sterling pound has gained 2.83 per cent against US dollar since April 2015, thus making imports cheaper and exports expensive and thereby denting international demand for UK goods. The currency has received support from the recent weakening in the US Dollar Index on account of disappointing economic data releases which has raised expectations of delay in US’ interest rate hikes. However, the ongoing political uncertainty has lowered potential investments in the UK markets, thus hampering the sterling pound. Prime Minister David Cameron’s Conservative Party is projected by a national exit poll to have done well in the British general election; it is quite likely that there would be no outright winner.

Cameron, if victorious, is committed to renegotiating Britain’s terms of membership in the European Union and to hold a referendum on whether to stay in the bloc by the end of 2017. So this remains a bone of contention not only for UK but also for the EU. Also, an interest rate hike remains distant as the fall in crude prices with a decrease in demand for goods has led to lower inflation rate since 2013, leading to BoE’s reluctance for interest rate hike in the near future. The inflation rate is expected to stay lower for a longer period of time due to uncontrollable external factors and has led to speculation that the interest rate hike will be in 2016 instead of 2015.

Strategy: Sell NSE GBPINR between Rs 100.50 – 101, SL – 104.50, Target – Rs 93 (CMP – Rs 99.25)

Disclaimer: The above opinion is that of the author and is for reference only.