Will Sterling Be Downgraded?

Could the “Queen’s Currency” about to be downgraded? ETX Capital looks at the ramifications for sterling should the UK lose its AAA status.

Sterling finds itself under renewed pressure as the possibility of a ratings downgrade (as imminent as this week, according to some) looms ever larger.

If indeed the UK does lose its AAA credit rating, then any last embers of a “safe haven” type environment (established because of the even weaker performance of rival economies) would likely dissipate, especially if investors decide (rightly or wrongly) that the euro zone and US are finally emerging from the doldrums.

The lack of signals suggesting that there is any decent recovery happening any time soon means the Bank of England (BoE) may have to “loosen monetary policy” even further this year and throw the “Carney factor” in to the equation. This further uncertainty, initially at least, adds to the bearish sentiment that prevails.

The sterling currently sits at lows against the USD not seen since last July and, perhaps more tellingly, is pushing lows against the euro not seen since the winter months of 2011. Last week’s Retail Sales data release for January, managed to disappoint a market that was already prepared for mild disappointment! The latest BoE quarterly inflation report forecasting higher inflation and weaker growth prompted comments from various experts, amongst them the MPC’s Martin Weale, that the currency may well need to weaken even further to try and help address the problems facing UK plc.

In normal circumstances you could be excused for thinking that a significant drop in the value of your currency, should and would help kick start the economy, helping make exports cheaper and thus reducing the gap between levels of imports and exports. But, theory is one thing and the reality hasn’t panned out as expected (albeit in the face of an unprecedented global recession.)

Indeed Governor Mervyn King has suggested that the “Old Lady” would be prepared to tolerate higher inflation in a bid to support the economy. Added to that, a cursory trawl through recent commentary suggests no-one will be losing any sleep over a gradually weakening sterling. Consider also the recent news that the UK is expected to show a current account deficit of circa 4 percent of GDP in 2012 and the arguments for the currency to fall further still, stack up even more.

In financial markets where investor sentiment is “nervous” at best, the news from the Commodity Futures Trading Commission that “Short” sterling bets are currently the largest since last June comes as no real surprise, with a recent FT poll showing support for leaving the EU growing also unlikely to have helped the Queens Currency” cause! In terms of weakness, GBP is only being usurped by the yen and we all know what’s going on there…

However before we get all gung-ho and rush out and sell everything sterling, remember that these things never move in straight lines. There is bound to be some “ebb and flow” in a currency pair that has come off the best part of 10 big figures since the start of the year (£/$ or Cable as it is known was up at the dizzy heights of 1.6380 before the Christmas decorations were fully taken down), and in the last few days we have seen some tentative profit taking, although this may well be some position adjusting ahead of the release of the MPC minutes on Wednesday (20th Feb) and UK GDP on the 27th.

So beware of any squeeze the longer we manage to hold above 1.5400/30 but “sell rallies” seems the markets weapon of choice at the moment, with resistance levels at 1.5550/1.5600 likely to be respected and with initial supports at 1.5400 and key support at 1.5270 below that.