Tuesday, 10 February 2009

Sterling, doomed?

As regular readers will know, I'm extremely pessimistic about the long term value of sterling, despite its rally of recent days. The coming money print run, quantitative easing in the jargon, and the massive government debts will both tend to devalue the UK's currency, and letting inflation rip is the easiest way out of the current debacle for the government.

Here are some thoughts from Credit Suisse on what QE will do to various major currencies:

EUR: QE is difficult for the euro area, an institutional weakness that has also caused sovereign spreads to widen sharply. Although difficult, it is not impossible, in our view. We believe a resolution of these concerns would be a structural positive for the euro’s role as a reserve currency. Although it would not improve the weak macro backdrop, we think it would allow the euro to participate in a new round of generalized dollar weakness.

CHF: The SNB has indicated its willingness to use QE and has explicitly mentioned FX intervention as a means to achieve its objectives. We suspect that unlimited intervention is unlikely and that intervention is more likely to be used to offset CHF strength than cause weakness.

JPY: QE’s implementation was unsuccessful earlier in the decade and the BoJ is very reluctant to allow rates to return to zero. Following the Fed’s lead, it is now starting to try to improve domestic credit mechanisms, but remains hampered by residual weaknesses in the domestic financial system and appears unwilling at this point to seek to resolve them aggressively. JPY strength through deleveraging comes from its net international surplus of foreign assets. A continuation into accelerated QE elsewhere is possible if monetary expansion proves hard to control.

USD: The early stages of QE haven’t hurt the dollar because deleveraging has increased foreign demand to buy back dollars previously used to fund the accumulation of USD assets, which have now fallen in value. At the same time, the destruction of wealth leads to increased domestic money demand to preserve capital. We expect these forces to wane through the year and for the dollar to weaken as QE is expanded.

GBP: The pound has weakened sharply in anticipation of QE. A Balance of Payments structure that relied on debt inflows to permit a combination of elevated consumption and accumulation of leveraged foreign assets helped create an ‘international ALM mismatch’ that has now been exposed. Even at current valuations, we think GBP is vulnerable to QE because attempting to underpin a leveraged national balance sheet through sovereign debt expansion is inherently unstable given the threat of domestic capital flight. By contrast, GBP could benefit from successful US implementation of a bad bank plan that underpins broad asset price expectations.

A couple of interesting things to note:

1/ There's a body of opinion that QE has already started under the covers in the UK. Not officially, but some BoE publications tend to indicate that printed cash has been slipping from the BoE to HM Treasury to pay for some day to day spending as tax receipts have not been as expected due to the economic wind-down.

2/ The Swiss seem to be intervening to keep their currency down rather than prop it up, and we all know bucking the markets doesn't work forever.

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