The Pound Drops Over Fears Of Further QE

17 May, 2012

Despite data showing that unemployment was down for the second month in a row, comments from the Bank Of England caused the value of sterling to drop slightly, but rapidly. BoE director Mervyn King forecast weaker growth in the UK economy than was originally predicted, from 1.2% to 0.8%, causing the value of sterling to drop away from the 3 1/2 year high that we’ve seen so far this week. Sir Mervyn indicated that he believed the Euro was ‘tearing itself apart’, and that if the Euro was to suffer a major crisis, Britain would be directly affected, saying – “”We have been through a big global financial crisis, the biggest downturn in world output since the 1930s, the biggest banking crisis in this country’s history, the biggest fiscal deficit in our peacetime history, and our biggest trading partner, the euro area, is tearing itself apart without any obvious solution. The idea that we could reasonably hope to sail serenely through this with growth close to the long-run average and inflation at 2% strikes me as wholly unrealistic”. This raises the possibility that in future months the BoE might decide to introduce further Quantitive Easing measures, which would likely weaken the pound further in the short term. It is worth noting that King’s comments yesterday caused the rate of Sterling vs Euro to drop even more sharply than the announcement that the UK is in recession, and was only stopped from dropping further by the positive employment data.

David Cameron seems to be starting to pay more attention to the issues in the Eurozone, saying in Prime Ministers Questions that if the Eurozone intends to survive, it must construct a ‘firewall’ to secure the weaker members of the single currency. The key ‘weaker member’ is, of course, Greece, and with the failure of their elections in the past week, it seems unlikely that the problems there will be resolved any time soon. With anti-austerity parties leading the way in polls, the ECB is worried about Greece being able to pay off their debts, which would cause it to drop out of the Euro, causing a ‘ripple’ effect across the continent, particularly effecting weaker economies like Italy or Spain. A G8 summit later this week is likely to feature Greece’s problems quite highly on the agenda.

The best news yesterday came for the US Dollar, which gained strength against both sterling and euro, with the pound falling 1% against the American currency. However, despite negative news for sterling yesterday, analysts see its ‘bullish’ run against the euro to continue. It remains to be seen if the UK currency will increase its strength against the Euro sooner, rather than later.