Cameron Economy Set to Take a Pounding as Traders Turn Bearish

By Lukanyo Mnyanda and Paul Dobson - Aug 23, 2010 12:25 PM GMT+0800


U.K. Prime Minister David Cameron attends a summit in New Delhi. Investors drove the pound as much as 11.8% higher against the euro from its low this year on March 1 on speculation Cameron's austerity measures would shrink the nation's 11 percent deficit and preserve its top debt rating. Photographer: Pankaj Nangia/Bloomberg
Audio Download: Debate on Pound

The British pound’s biggest rally in 14 months is in jeopardy as Prime Minister David Cameron’s budget cuts begin to curb economic growth.

Foreign-exchange forecasters are the most pessimistic on the pound since May 2009, when Standard & Poor’s said the U.K. was at risk of losing its AAA credit rating, according to data compiled by Bloomberg. Bears in a Bloomberg survey of strategists outnumber bulls 29 to 12, while TD Securities in Toronto, the most-accurate forecaster in the six quarters ended June 30, has the lowest estimate, predicting sterling will depreciate 15 percent versus the dollar by year-end.

“The story has changed,” said Richard Benson, an executive director at Millennium Asset Management in London who oversees $14 billion and correctly predicted in the first half of 2009 the pound would gain versus the euro. “The prospects for growth look quite soft and fiscal retrenchment is about to be undertaken,” said Benson, who is betting against sterling as the U.K. expansion lags behind Germany.

Investors drove the pound as much as 11.8 percent higher against the euro from its low this year on March 1 on speculation Cameron’s austerity measures would shrink the nation’s 11 percent deficit and preserve its top debt rating. It’s starting to retreat as the planned cuts risk undermining the recovery.

Trimming Forecasts

The Bank of England lowered its 2012 growth forecast on Aug. 11, to 3 percent from 3.6 percent, citing “tight credit conditions” and the budget program. The U.K. will probably expand 1.2 percent this year, the median estimate of 24 economists surveyed by Bloomberg showed. German gross domestic product may increase 2 percent this year, with the U.S. rising 3 percent, separate surveys show.

Gains in London house prices in the first-half of 2010 were wiped out this month as the market weakened, Rightmove Plc, operator of the U.K.’s biggest property website, said on Aug. 16. Consumer confidence dropped in July for a third month, data from Nationwide Building Society showed on Aug. 11.

Benson said sterling will weaken more than 8 percent against the euro by year-end, from 81.83 pence last week. It rose 0.2 percent 81.69 pence and to $1.5564 from $1.5534 as of 12:42 p.m. in Tokyo.

“It’s a turning point for the pound,” said Ian Stannard, a London-based senior currency strategist at BNP Paribas SA, the third-most-bearish of 34 forecasts for the pound against the dollar compiled by Bloomberg as of Aug. 20. “The data has peaked and it’s set to deteriorate.”

The pound fell 12 percent from the start of the year to a low of $1.4231 on May 20 on concern former Prime Minister Gordon Brown’s Labour Party would fail to tackle a budget deficit that had reached 12.6 percent of the economy.

Cameron Takes Over

Cameron’s Conservative Party ended 13 years of Labour rule in the May 6 election and formed a coalition government with Nick Clegg’s Liberal Democrats, promising cuts to tackle the shortfall. Sterling jumped 7.9 percent against the dollar in the two months through July.

Governments across Europe are attacking deficits after the region’s debt crisis sent bond yields in Greece, Portugal and Spain to the highest relative to German bunds since the euro was introduced in 1999 and prompted credit downgrades by S&P, Fitch Ratings and Moody’s Investors Service. S&P reiterated the “negative” outlook for the U.K. on July 12, saying its projections for the economy were less optimistic than those Chancellor of the Exchequer George Osborne presented in his emergency budget on June 22.

Osborne, 39, the youngest chancellor since 1886, pledged to almost erase the deficit by 2015 via spending cuts worth 30 billion pounds ($47 billion) annually and measures including a public-sector wage freeze, firings and tax increases.

Gilts Rise

Gilts climbed that day as the Debt Management Office reduced the amounts of bonds to be sold in the fiscal year through March to 165 billion pounds from 185.2 billion pounds. U.K. bonds have returned 5.74 percent since May 6, compared with 3.95 percent on average for government bonds globally, according to Bank of America Merrill Lynch index data.

“The actions we took in the budget have removed the biggest downside risk to the recovery, a loss of confidence and a sharp rise in market interest rates,” Osborne said in a speech at Bloomberg’s London offices on Aug. 17. “Britain now has a credible plan to deal with our record deficit. We must stick by it.”

Strategists who boosted fourth-quarter predictions for the pound to as high as $1.67 in January now see the currency declining to $1.51 by year-end, according to the Bloomberg survey’s median forecast.

Pound Forecasts

TD Securities predicts sterling will end the year at $1.32. BNP Paribas, based in Paris, estimates the pound may slide to $1.40, while Zurich-based UBS AG, ranked by Euromoney Institutional Investor Plc as the world’s second-biggest foreign-exchange trader, forecasts a drop to $1.35.

Against the euro, the pound will likely end the year at 81 pence, based on the median estimate of 27 economists and strategists. As recently as April they forecast 87 pence.

“The appreciation we expected several months ago has now occurred and most likely overshot,” said Camilla Sutton, head of currency strategy at Bank of Nova Scotia in Toronto, who sees the pound at $1.53 by Dec. 31. “The pound faces several ongoing hurdles, including the outlook for inflation and the Bank of England.”

The pound is weakening even as inflation shows few signs of slowing. The currency fell 0.5 percent on Aug. 17 even though the Office for National Statistics said U.K. consumer-prices increased 3.1 percent in July from a year earlier, above the government’s 3 percent limit.

Futures Traders

Futures traders have reversed bets that the pound will gain against the U.S. dollar, data from the Washington-based Commodity Futures Trading Commission showed on Aug. 20.

The difference in the number of wagers by hedge funds and other large speculators on a decline in the pound compared with bets on an advance, so-called net shorts, was 4,431 on Aug. 17, compared with net longs of 5,021 a week earlier. Net shorts were as much as 76,745 in May.

“We still find sterling attractive,” said Thanos Papasavvas, who helps invest about $5 billion as head of currencies at Investec Asset Management Ltd. in London. “It’s more to do with the U.S., which is behind the curve on the fiscal adjustments. Economic reports coming out of the U.S. have been disappointing, whereas data from the U.K. has been better than expected.”

The pound will trade between $1.65 and $1.70 by year-end, Papasavvas said.

‘Cautiously Optimistic’

Osborne said in his speech on Aug. 17 that economic data pointed to a “gradual recovery.”

“We can start to be cautiously optimistic about the economic situation,” he said.

Bank of England Governor Mervyn King may resist further gains in the pound to promote exports and industries including tourism that have benefited from a 24 percent drop in sterling on a correlation-weighted basis since the start of 2007.

Retail sales in central London grew at the fastest rate since 2006 in the five weeks to July 3 as visitors to the U.K. took advantage of the weaker currency, the British Retail Consortium and accounting firm KPMG LLP said on July 19.

“The governor has been arguing the case for an export-led recovery,” said Robin Marshall, a director of fixed income at Smith & Williamson Investment Management in London, which oversees $20 billion. “A much stronger exchange rate would not be very welcome. He would attempt to talk it back down if we did get back toward the $1.70 level.”

A weaker pound may not be enough to give an additional kick to the economy as Cameron’s austerity program slows the recovery, said Brian Kim, a currency strategist at UBS in Stamford, Connecticut.

“The fiscal side in the U.K. is going to hamper growth,” Kim said in an interview. “We could see more sterling weakness in the second half of the year.”