Is the UK Facing a Currency Crisis?

As the cable continues to fall, reaching levels not seen since 2010, speculation is mounting that the UK is facing a currency crisis that could rival that of the Thatcher era.

The Pound’s meteoric fall commenced in the middle of December and has continued unabated to its current level around the $1.44 handle. Subsequently, market strategists have rushed to downgrade their 2016 forecasts amid both US strength and a softening UK inflation outlook. In fact, ING Bank is now predicting a fall of 8 percent that would see the venerable pound trading around the $1.32 level. A valuation within the $1.27 - $1.32 range likely stirs memories of the currency crisis experienced by the UK during the Thatcher era where the Pound fell to as low as $1.27.

Although there are many reasons to retain a bearish view towards the Pound there is little in the way of similarity between the current UK economic conditions and those during the 1980’s. Although the UK inflationary expectations remain depressed, employment is still relatively strong at 5.2%, whereas the 1980’s saw unemployment reach levels not seen since the depression. The Thatcher era also grappled with rampant inflation which peaked at around 21% before declining under the conservative government. In short, the Britain of today bears little in common with the nation during the last major currency crisis.

In the global capital markets, the decline of the Pound has had more to do with US strength and waning capital flows then it does with perceived macroeconomic weakness within the UK economy. In fact the Pounds price action is a study in two central banks with divergent, out of step, monetary policies. Subsequently, the gap is likely to be exacerbated as long as the US Fed forges forward upon a tightening cycle in 2016.

It is therefore highly likely that we could see further depreciation of the Pound in the coming months as the market increasingly takes a bullish view towards the US Dollar. However a valuation as low as $1.25 seems relatively unlikely given some of the recent UK economic data points. Although inflation is likely to be absent into 2017 the UK economy remains robust and is unlikely to require any further easing. This subsequently provides for a limited downside and, as such, my medium term forecast has the Pound remaining about the key $1.40 handle.

Despite the limited downside, a risk event certainly looms upon the horizon as the push to split from the EU gathers steam. Any move to undertake a BREXIT could cause an unpredictable reset to the Pounds valuation that would be problematic to predict.

Ultimately, the Pound is in for a rough ride throughout much of 2016, but there is little evidence to suggest that a currency crisis is afoot that would near that of the Thatcher era. Subsequently, keep an eye out for further Pound depreciation but rest assured that UK macroeconomic environment bears little in common with that of the 1980’s.