Why the pound is going up

MoneyWeek
AREP2G Money
AREP2G Money



Today we consider the pound, which is doing rather well all of a sudden.

It's reached five-year highs against the euro, the yen, the Canadian, Aussie and Kiwi dollars. It's even looking good against the almighty US dollar.

And I think that's going to continue.

In many ways, the core argument that determined our choice of party at the general election in May came down to one simple question.

What percentage of GDP should the government be spending?

At different stages, the debate focused on the health service, on welfare and education. There were discussions about mansion tax, help-to-buy and right-to-buy. We got rows about income tax, inheritance tax, and bedroom tax, about subsidies, pensions, overseas aid and defence.

But they all boil down to that same issue: how much should the government spend, and on what?

It could be argued that even immigration (with its effects on local labour, welfare, infrastructure, and government tax revenue), and the still unresolved issue that is UK EU membership both have this question at their heart.

And – Scotland aside – the electorate voted in favour of less government spending. (It might well be that, given fiscal autonomy, Scotland would soon change its stance.)

And it seems that so far the forex markets agree with that decision.

Why the pound was on the slide

In the 12 months leading up to the election, the pound got the jitters. Perhaps misled by the polls, forex (foreign exchange) traders were unsure what the electoral outcome would be and they sold sterling.

In July 2014, a pound got you $1.70. By the middle of April 2015, it was worth just $1.46.

In apparent jubilance at the outcome, the pound shot up to $1.58 in the days after the election. Then we got some profit-taking – a so-called retracement.

But now, having found a floor at $1.52, the pound seems to be on the up again and we're now at $1.56 and rising.

For all the choppiness and notorious volatility of the forex markets, my experience is that once trends are in place, they can go on for many months. And I'm of the mind that we're now fairly early into one such uptrend.

At the time of the election, I argued that Cameron would win and we'd see $1.60 before the end of the year. With the victory coming in the way that it did, I'm revising my target to $1.70.

The manufacturing revival is boosting Britain

Of course, a lot will depend on the contents of the Chancellor's budget. It's going to be interesting to see where he finds that £12bn of promised cuts.

But the noises he is making – particularly his proposition last week to make budget deficits illegal – make his intentions pretty clear: less government spending.

And the message from the forex markets at the moment is clear too: if you want a strong currency, spend less.

At the Moneyweek conference last week, Pippa Malmgren spoke with great enthusiasm – in the way that only an outsider can – about the economic growth she sees unfolding in the Manchester-Birmingham corridor, particularly in manufacturing.

At the same conference, I met up with my old friend, Sebastian Chambers. His management consultancy, CIL, acts for a large number of small- and mid-cap firms across the UK, again many of them in manufacturing.

"Our business has grown by 50% this last year", he told me in an almost incredulous whisper. "Our companies are doing incredibly well. And it's not just us. There's a real boom going on. Many people don't seem to realise."

These are the sort of hushed disbelieving tones on which bull markets are formed.

I know these are just two anecdotes that I'm citing to support my narrative. It'll be another year before we see confirmed numbers. But for all our many financial and economic problems, UK plc seems to be doing well.

And the decision made at the general election should help that continue. When government spends less, it takes less too – and that gives businesses room to thrive, invest and grow.

Sterling is hitting highs against many currencies

It's worth noting that it's not just the dollar against which the pound is rising. I should say I'm not particularly bearish about the dollar. I'm just bullish about the pound.

In my trading account, I'm currently long the pound against both the Australian and Canadian dollars, the commodity currencies in other words. Sure, we're running into some resistance now, but sterling is not far off five-year highs against these.

The disaster in oil and metals has hit those currencies hard – as it has the currencies of many emerging nations. Indeed, emerging markets have got plenty of their own problems – probably the most pronounced being Brazil.

And there's the pin-up child of currency disasters that is the euro. Here the pound is also approaching a five-year high – we're approaching the halcyon days of pre-financial-crisis strength.

In fact, the euro is so weak you can't help thinking it's got to rally soon. Perhaps a Grexit will make that possible.

Whether by design or accident, the UK seems to have sandwiched itself in this nice little niche where we are avoiding many of the problems that are hitting other countries and thriving.

In case you didn't get it, I'm bullish about the pound. And I'll stay bullish until the charts tell me otherwise.

Sure I can find a load of things in the UK economy to be negative about (high house prices remain a real barrier to activity) – but that's all part of the wall of worry that bull markets climb.

A strong pound means that holidays abroad are going to be that much more fun.

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