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Cable – what is the downside for Sterling?

16 May 2008

The Technical Trader’s view:MONTHLY CHART:

The bulls for Sterling will have been very disappointed by the failure of the market to hold above 2.005 (the old high from 1991) once it had broken through on the way up.

Because in bull markets prior highs are supposed to be good supports.

This was the first clue for the bears that all was not well for Stelring.

They will have noted the resilience of the support from the Prior High at 1.9549, but wonder whether this latest bear attack at that level will finally break down ...

Moreover, there is may be an imperfect Top in the making.

Watch carefully for the market to complete a bear Head and Shoulders Top if it breaks down through the possible Neckline at 1.94 or so.

Watch closely and wait for the break to herald another quick bear move for Sterling.

If that happens the minimum measured move is low as 1.75.

(That would be back to the lows of 2005 and 2006)
The Macro Trader’s view:
Against the Dollar, Sterling hit a high back in November 07 and has since experienced weakness which now seems to be gathering pace, but how much further can it go?

As the credit crunch began to ring alarm bells over the UK economy at the end of 2007 a housing market correction capable of undermining the strength of the entire economy seemed likely.

By contrast, the Eurozone economy continued to record solid growth data, but suffered a spike in inflation that prevented the ECB from cutting interest rates, allowing the Euro to rally further against all the major currencies.

Is the Pound about to embark on a serious bear path and hasn’t it already weakened enough against the Euro, which now sees growth in the Euro zone starting to show signs of faltering?

In our opinion the Pound can weaken much further against both the Dollar and the Euro. The recent attempt at a recovery was driven by an unsustainable blip in the data:
- The last Retail sales report had come in better than expected, and
- Until this week, CPI was reasonably benign.

But on Tuesday CPI came in much worse than expected at 3.0%. Worse still, the Bank of England’s quarterly inflation report forecast it could go to 4.0% if rates were cut further. If this wasn’t bad enough, the report also forecast that growth was likely to be much weaker than previously expected, with the possibility of recession.

This leaves the Pound extremely vulnerable; the MPC will be unable to hike rates in order to control inflation as this would be politically unacceptable given the current outlook for growth. Only today Gordon Brown said he hoped the Bank of England would be able to cut rates further. Imagine his reaction if instead they hiked! Although independent, the Act of Parliament that granted Central Bank independence allowed for the politicians to regain control in an emergency.

With house prices now falling y/y and even the Government privately expecting a decline this year of at least 10%, rate hikes aren’t an option.

But the MPC will struggle to ease policy to support growth given their forecast for inflation. Add to this the recent loosening of fiscal policy in an attempt to placate the 10p tax rebels in the wake of disastrous local election results, and the currency looks to be on shaky ground.

In an economy that makes very little, imports most of what it needs and as a result is a natural seller of its own currency, Sterling’s strength is derived from confidence in the soundness of the economy and the government’s policy towards it.

Once that confidence is lost, there isn’t much to support the Pound, and we sense we are at such a juncture. In short, watch the Pound fall.

Mark Sturdy
John Lewis
Seven Days Ahead

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