The Fall of Sterling: Propects and Potentials

One important lesson that can be learnt from the current global financial crisis is that no institution, country is immune from its impact. The bigger you are, the harder you fall. One good example is the mighty pound sterling fall from grace. Pound sterling decline substantially compare to the euro. By today, euro has reached parity with the sterling. The impact has even affected EPL clubs as weakness of sterling means less euros to buy or pay the wages of Continental European footballers.

UK economy and financial institutions are the second hardest hit after their American brothers. You can say it is like an Anglo-American crisis. The flight of safety to US Treasury securities add to the woes of pound sterling. But I believe the big decline is unjustified in the long term. Firstly, London's role as the world premier financial centre remains unchallenged even with the introduction of the euro. Secondly, the UK government has set up 50 billion pound sterling fund to bail out Big 8 financial institutions in UK. So far none has utilized the fund. This has avoided serious bank runs and systemic failure in the UK financial system. Thirdly, based on 35 years history, pound sterling has bounced back strongly each time it has declined to a bottom. The last bottom was in 1992 after the sterling was attacked by George Soros. The sterling is just like a high beta stock. The RM 5.2 rate against the sterling is the lowest since 1998. Average rate during this decade is RM 6.

Bank of England interest rates have fallen from a peak of around 5% to only 2% due to the sub prime mortgage crisis and the economic recession. At the same time RM deposit rate remains around 3% as opposed to sterling deposit rate of 1.75%. This has turned the negative interest rate differential to postive. I expect the sterling to fall below RM 5 mark if BOE continues to cut rates. It will depend again on the next quarterly result of the British economy. In UK, the mortgage market is sensitive to interest rates movement. I don't expect a recovery of the UK economy for another 3 more quarters. Thus, I believe more rate cuts are in store in the next 2 quarters. I speculate a cut to 1%, slightly above 0.75% by the US Fed. All things remain constant; sterling is expected to slide below RM 5. That would definitely make the sterling an attractive currency to speculate or invest in. Sterling bear will dominate 2009 but be prepared for a turning point end of this year.