Tags: England | pound | energy | markets

Bank of England Comments Whipsaw Value of British Pound

Bank of England Comments Whipsaw Value of British Pound

 (Dreamstime)

By    |   Wednesday, 26 October 2016 08:21 AM

The Bank of England Governor Mark Carney’s testimony yesterday before the House of Lords had an unusually clear impact on the value of the British pound with the currency weakening again in advance of his testimony before and then in rallying mode when he indicated that the Bank of England was not indifferent to the value of the pound.

There are essentially two arguments going on here:

  • The vulnerability of the pound sterling, and
  • The impact that sterling weakness has on the UK domestic economy.

On the first point, the value of the British pound as a currency of a current account deficit country is determined by the price at which foreigners are prepared to purchase sterling. That has been true for foreign direct investment for years, which is normally a good thing as foreign direct investment is a more dependable source of capital flow.

With the UK government giving the impression of greater hostility to foreigners however, this flow is vulnerable. The Bank of England Governor can hope to try and mitigate that by attracting portfolio inflows through giving the impression that rates will not go down any further.

On the second point, the issue is the extent to which its currency weakness is passed through into domestic inflation. Normally, a currency pass through is confined to commodities, but because this is seen as a structural change in the value of sterling, there is a greater inclination to pass on price increases.

Moreover, sterling appears to be being used as an excuse by some companies. The most important price review for UK inflation is domestic wages. Import prices play a far lower role than is commonly supposed, but the popular misconception about the role of import prices allows companies to pass on higher price increases and blame it all on the foreign exchange markets.

Meanwhile, energy markets have been exhibiting increased volatility with the oil price dropping on comments and as reported by Interfax that Russia’s envoy at OPEC, Vladimir Voronkov, stated “Output cuts aren’t “an option for us,” which clearly implies that OPEC could cut production in November if it wants to, but Russia isn’t especially concerned. 

That said and probably nothing more than coincidence, but this development came on the same day as when the International Energy Agency (IEA) stated in its just released “Median Term Market Analysis and Forecasts to 2021” that for the first time, renewables accounted for more than half of net annual additions to power capacity and overtook coal in terms of cumulative installed capacity in the world. 

Please take care, this is a bit misleading as green energy cannot work at full capacity all the time while coal can. A power plant’s capacity is the maximum amount of electricity it can potentially produce. The amount of energy a plant actually generates varies according to how long it produces power over a period of time. Because a wind or solar farm cannot generate constantly like a coal power plant, it will produce less energy over the course of a year even though it may have the same or higher level of capacity. So, coal is still king in output terms. Nonetheless, the trend raises some interesting questions.

From an economic point of view, and this is important for long-term investors, the fact is that energy prices are unlikely to fall significantly from here removes the dis-inflation illusion that lower energy prices have created in recent years.

However, if energy becomes a more stable part of inflation in the future, that should refocus attention back on to domestic labor costs as the primary inflation driver that by the way and according to the U.S. Bureau of Labor Statistics increased 2.6 percent on a yearly basis during the second quarter of 2016.

U.S. consumer confidence dipped in October, after back-to-back monthly gains.

No doubt, the potential for political influence is strong here.

Looking deeper into the details and more specifically at the demographics of the confidence data, it is noticeable that the weakness came from the lower income bracket that represent the demographic “left behind by economic prosperity.” A demographic that has been more inclined to back Trump.

This just underscores the problems of being too dependent on sentiment surveys for the moment.

In Europe, Canada’s Prime Minister will be speaking today at the European Parliament in what could amount to a funeral oration over the corps of the EU-Canada free trade deal, known as the Comprehensive Economic and Trade Agreement or CETA, with, and this is very important, all what that entails for future potential trade deals with the EU.

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The Bank of England Governor Mark Carney's testimony yesterday before the House of Lords had an unusually clear impact on the value of the British pound with the currency weakening again in advance of his testimony before and then in rallying mode when he indicated that the...
England, pound, energy, markets
766
2016-21-26
Wednesday, 26 October 2016 08:21 AM
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