One of the greater ironies in the capital markets is the fact that UK with a gross debt to GDP ratio of 143% – rivaling that of Greece – finds itself sporting a yield of 1.69% on its benchmark 10 year bonds. The remarkably low yields and the very high debt ratio are the result of unique circumstances that have made UK and by extension the pound a primary destination for safe haven flows in Europe.
With Swiss National Bank, persistently intervening in the currency markets to lower the value of the franc, sterling has become the only free floating European currency available to investors and as such has benefited mightily from safe haven flows as capital flight out of euro has kept the unit bid irrespective of the weak fundamentals of the UK economy. However, this dynamic may be changing and the day of relative outperformance for the Great Britain pound may be quickly coming to an end.
Last weekâ€™s surprising productive European summit may have quelled some of the concerns regarding the safety of EU sovereign debt and this week if the ECB proves accommodative, the euro should continue to recover as stress in the regionâ€™s credit markets begins to ease. Meanwhile UK faces a challenging week both on the economic and the political front. The UK economic calendar is full of PMI reports with most market analysts anticipating a deterioration in the data as the countryâ€™s economy continues to face the threat of contraction for the third quarter in a row. UK economic performance has been dismal lately with claimant count rising by 8.1K versus -3.1K eyed, mortgage approval falling to their worst pace on record and Index of services remaining flat versus 0.3% forecast gain. Meanwhile the strong currency has wrecked the countryâ€™s terms of trade with Current Account deficit ballooning to -11.28B versus -8.9B eyed and Public Sector Net Borrowing has once again exceeded estimates rising to 15.6B versus 13.6B making a mockery of Prime Minister Cameronâ€™s attempts to implement an austerity policy.
Yet despite clear problems on the economic front, the greatest threat to cable may be political this week. The growing scandal over the manipulation of the LIBOR rate (which is used as a reference point in everything from mortgage rates to credit card debt) could become a serious business liability for the UK banking sector which has been heavily implicated in the matter. Already, as result of the fallout Barclayâ€™s chairman Marcus Agius has already tendered his resignation and as the investigation unfolds, with possible criminal as well civil penalties, more banking executive could resign creating turbulence in UK capital markets.
Currencies generally abhor political scandal and if the probe into the LIBOR manipulation continues to dominate headlines, cable could begin to lose some of its safe harbor luster as the investigation proceeds. In addition to the LIBOR probe, currency investors will also be watching the BOE meeting this Thursday. The markets anticipate that the UK central bank will add another 50 Billion GBP to its asset buying program as it tries to stimulate the moribund lending sector. However, with key players under assault for market manipulation, BoE QE efforts may go for naught.
One interesting way to play the possible sterling weakness is through the EUR/GBP cross. The pair has formed a triple bottom at the 80.00 level and may be ready to 81.50-82.00 as it begins its recovery from the 1000 point sell-off over the last year. If the pair can break through the congestion at 81.00-81.25 then it would suggest that the days or relative strength for the pound may be over.