Posted by Gilmour Poincaree on November 23, 2008

November 21, 2008 – Reuters

By some measures, sterling’s recent slide is even greater than the fall in late 1992 when it was ejected from a group of European currencies, but the chances of a repeat rescue attempt from the Bank of England are minimal.

The doomed attempt 16 years ago to take on currency traders, most notably George Soros, to keep sterling in the Exchange Rate Mechanism cost around two-thirds of UK foreign exchange reserves and scarred the collective conscience at the BoE and Treasury.

But unless sterling’s fall becomes disorderly in the eyes of UK officials and threatens the stability of financial markets and business and trade with the rest of the world, analysts say the BoE and UK Treasury will be loath to try anything similar.

Indeed, as BoE officials have indicated, an export-boosting, weak currency may be one of the few bright spots on the horizon for the UK economy otherwise ravaged by the tumbling housing market and collapse of credit.

“The key issue for UK financial officials is to get the economy moving, to try to prevent a slowdown next year from being more pronounced,” said Trevor Williams, head of group economic research at Lloyds TSB in London.

“To some extent a weaker currency helps in that effort … so it’s the lesser of two evils.”

Sterling has tumbled 16 percent against the dollar so far this quarter, compared with more than 15.3 percent in September-December 1992. Implied volatility on one-month sterling/dollar currency options shot up to nearly 30 percent earlier this month, eclipsing a jump to 22 percent in October 1992.

During that period, UK authorities burned through as much as an estimated $30 billion by many accounts in an unsuccessful bid to stem the pound’s drop before permanently withdrawing from the ERM.

According to Willem Buiter, professor at the London School of Economics and former BoE policymaker, the depreciation of sterling’s effective exchange rate in the past year is larger than that in the year following the UK’s exit from ERM.

“There can be little doubt, however, that there is a point at which the weakness of sterling ceases to be the correction of an anomaly and becomes an anomaly and a problem. I believe we are close to that point,” Buiter said this week on his blog

But he ruled out the likelihood of the BoE wading back into FX markets to support the pound this time around, even though “a triple crisis” of sterling, UK sovereign debt and banking is a real threat.

“There is zero chance of the BoE intervening either on its own behalf or as agent of the government, unless the sterling forex market were to seize up or become illiquid and disorderly. There is no sign of that,” he said.

Sterling traded around $1.49 against the dollar on Friday, and analysts say authorities are willing to see sterling weaken towards a fair value range of $1.40-1.50 and a fall significantly under $1.40 would be needed for the prospect of intervention to even reach the table.


Sterling has fallen 25 percent against the dollar this year, hitting a 6-1/2-year low around $1.45 last week, when it also hit a record low against the euro of 86.62 pence and a 13-year trough on a trade-weighted basis at 80.5.

After the pound tumbled following the BoE’s 150 basis point cut in interest rates earlier this month, BoE Governor Mervyn King said that its fall over the past year was not surprising and was an inevitable part of rebalancing the UK economy.

UK Prime Minister Gordon Brown has also weighed in, blasting a suggestion from the opposition Conservative party that plans for the government to use borrowed money to spend its way out of the recession could trigger a run on the pound.

The pound’s slide so far has not fanned inflation risks and by common consent, having long been overvalued, analysts say authorities are happy to have it weaken.

Nor has it scared investors away from UK government bonds, which really would be a concern for policymakers. Demand for safe-haven bonds has helped to push the two-year gilt yield below 2 percent this week for the first time ever and 10-year yields below 4 percent.

“At the moment, we’re not seeing sterling weakness adversely affecting either the gilt market or bond yields or any government auction,” said Mansoor Mohi-uddin, chief currency strategist at UBS in Zurich.

He added that at the moment, a drop in demand for UK debt would likely be one of the few situations in which UK authorities would consider shoring up the currency, particularly given government plans to borrow its way out of the recession.

But analysts at Bank of New York Mellon say this may be happening already. They recently pointed out that outflows from UK fixed income instruments since September have offset around 75 percent of all the inflows seen since 2004.



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