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The Pain is Just Getting Started for the Pound

By    |   Friday, 27 Jun 2008 04:10 PM

Many U.S. traders woke up to a market in recent days that really moved their account balances quite a bit — if they were in any British pound pair. What happened?

U.K. retail sales unexpectedly rose by the most since records began in 1986, that’s all. So the retail sales bought the U.K. economy some time in the short run as it fuels their economy on a bit further.

Let's look at why: It was the hottest May ever recorded. So that really spurred a lot of clothing sales. Yet you can’t count on the sun powering your economy through.

But this month they got lucky. Retail sales rose 3.5 percent in the month. Wow! That was some serious buying within 30 days time.

But this is not a new day for the U.K. economy. The reasons are several. Let’s take a look at a few.

Firstly, don’t forget that food and energy costs have gone through the roof. And the more that you have to spend on higher-cost gas and food, the less you can spend on the remainder of the retail marketplace.

Next, don’t forget about those falling house prices. They’ve slid 9 percent this year alone. That’s the worst drop in 15 years. That doesn’t happen every day.

Think it’s all over? Central Bank chief Mervyn King says it has further to go. And he gets his hands on more real-time data than you or I could ever think of.

So falling house prices and higher food and energy costs are going to dampen consumer spending even more in the coming months. That's a given.

While the pound may have had a day in the sun (and retail sales a month in the sun), the party won’t be long-lived. The pound could break higher in the short term, but in the long run, eroding fundamentals are going to drag down this slowing economy.

Remember, the British have taken on a record 1.4 trillion pounds ($2.8 trillion) in debt. And those borrowing costs aren’t getting any cheaper.

In fact, just when the economists were predicting rate cuts, the bank surprised the market this month by holding rates steady. This will make it harder for individuals and corporations for the remainder of the year.

Then, add on top of that $142-plus oil and things like corn that hit almost $8 a bushel (a record also), and there are clearly issues. In fact, gas prices alone in the U.K. have literally doubled just since 2003. So all of this is sucking money out of consumers' wallets.

On top of that, it’s clear that the central bank and Chancellor of the Exchequer both want the economy to slow down as a tool to bring down inflation.

It’s going to be hard to fight these guys. So it's baked in. The U.K. economy will slow further, and these guys will see to it that it does, in fact, happen. The economy probably won’t need their help but, if it did, I’m sure they’d offer a hand.

Now I’m not just dreaming this stuff up. It came straight out of their very recent speeches. King made comments such as “British living standards will be required to slip and growth to weaken."

In the Bank of England minutes this idea was also reinforced by this statement: “Slower growth will be necessary to have inflation return to the 2 percent inflation target.”

Then, the same day, Chancellor Alistair Darling tag teams Governor King and adds in his own comments in a speech that reinforces this whole idea.

Darling stated that “the economy is headed for a slowdown” and suggested that the impact of a worldwide squeeze on borrowing costs is continuing. He called on companies to "keep a lid on pay raises that may embed faster inflation.”

That’s right…the Chancellor is not in your corner, Mr. U.K. Consumer. He’s telling your bosses to not give you raises. How do you like that? Horrible, huh?

Now you see why I say things are going to get worse, which will ultimately bring the pound exchange rate down even further.

When you see the signals that these guys are dishing out in their speeches, the handwriting is on the wall.

Chancellor Darling went on to say that “times are tough” and that it would “take time for these global difficulties to work through.”

Well, that about sums it up right there, now doesn’t it? So when you can crawl into the minds of the leaders of the U.K. economy — the ones that help mold and shape it and hold its future in their hands — then you know where it’s all heading.

And believe me, it’s not looking good right now. So enjoy the little pop in the short term while it lasts, because ultimately the pull of gravity from the declining economy that’s basically being overseen by these leaders will put the brakes on.

When there are so many places in the world to shop for currencies, why go to the U.K. to park your money? You can go to more stable places that carry less risk, such as China, Brazil or Singapore.

Money loves to seek a high yield in a low risk environment due to a stable underlying economy — and that’s just not the present state of the U.K. economy.

So look for more money to sprout legs and run away from the U.K. and cause even more pound selling in the months ahead.

The GBP/USD pair will especially be affected as the U.S. eventually has to tackle its 4.2 percent annual inflation. Rate hikes will be needed in order to address this and get it back into the 2 percent to 3 percent comfort level of the central bank.

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Many U.S. traders woke up to a market in recent days that really moved their account balances quite a bit — if they were in any British pound pair. What happened? U.K. retail sales unexpectedly rose by the most since records began in 1986, that’s all. So the retail sales...
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2008-10-27
Friday, 27 Jun 2008 04:10 PM
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