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Daily Currency Market Focus

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Global Unwind Continues − Will the UK Become the Next Japan?

Wed, Nov 12 2008, 15:13 GMT
by Kathy Lien

GFT

The global unwind continues this morning with US equities, commodities and currencies taking another beating. The US dollar and Japanese Yen continue to outperform while the British pound hit a fresh 5 year low.

The story is still the same, which is sell first and ask questions later. It is earnings season and the reports that we have seen so far are a harsh reminder of the growing problems in the US economy. Retail sales are due for release on Friday and the warnings from retailers indicates that consumer spending has slowed materially. Best Buy cut its full year forecast today, DHL is shutting down its US operations and Circuit City became the 14th retail chain to go bankrupt, joining companies like Linen N Things and Steve and Barry.

We are in a global easing cycle and the market expects central banks around the world to follow the UK's aggressive interest rate cuts.

Is the UK Becoming the Next Japan?

When the Bank of England cut interest rates by 150bp last week, I turned aggressively bullish EUR/GBP on the belief that interest rates are headed below 2%. The currency pair has now hit a record high as the market realizes that not only will UK interest rates fall below 2%, but could be headed to Japanese levels. Against the dollar, the British pound has fallen to fresh 6 year lows but the historically significant moves are in EUR/GBP.

According to the November Inflation Report, the monetary policy committee believes that inflation will fall below their 2 percent target with the potential of hitting 1 percent. With price pressures expected to ease significantly, the Bank of England sending a strong signal that interest rates will continue to come down.

There is talk that the recessionary conditions in the UK economy could turn the UK into the next Japan. Another 200bp of easing by the end of the first quarter has been priced into the markets, which would take interest rates to 1%. If the BoE chooses to overshoot monetary stimulus, UK interest rates could be at Japanese levels. Mervyn King has become quite a maverick and given his fear of deflation, we would not be surprised to see another large rate cut from the central bank.

When the dust settles, the UK's aggressive monetary stimulus should turn their economy around faster than the Eurozone or the US, but in the meantime, more rate cuts mean more weakness for the British pound.

Published on  Wed, Nov 12 2008, 15:14 GMT