Don’t Put the “Great” Back in Britain Quite Yet

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As an Englishman it pains me to say it, but the recent run of good news about the UK economy may be a false dawn, at least if the forex market is to be believed. I should issue two disclaimers here. Firstly, as I said, I am originally from the UK, so anything I write could well be tinged with the either the rosy glow or irrational cynicism that separation from one’s native country often imparts. Secondly, my background is in the forex market, so I am more inclined to trust what that market tells me than anything else.

Actually, the forex thing stands up to a dispassionate, rational analysis. Whether you like it or not, we live in a global economy, where money shifts between countries as readily as it does between assets, and some of the world’s smartest minds are devoted to deciding where it should go. You may see this as a colossal waste of resources, but the fact is that it makes the flow of money a decent indicator as to the relative economic health of nations.

If you were to look at the British economy in terms of the stock market (FTSE100), it appears that the recovery from the woes of 2008/9 is intact.

 

Here in the US, however, the picture has been somewhat clouded by QE giving a boost to the equity market. If you look at GBP since the recession a different story unfolds.

The British Pound Sterling (GBP) as represented by Cable (GBP/USD) has seen some inflows over recent weeks, following some data releases, but the recovery in the “proud pound” has been somewhat anemic when looked at in a larger context.

 

Now it could be argued that pre-recession levels above 2.0 represented an overbought Cable market, but even so it is hard to look at this chart and say that there is any great confidence in the UK economy when it comes to capital flows.

It seems to me that there are a couple of things that should make investors cautious about jumping on the UK bandwagon right now.

Firstly, the economic fortunes of the UK are inexorably tied to those of the EU. Despite the UK’s decision not to be part of the Euro, the country still depends on the Euro zone for around 50% of its international trade. The Euro crisis has faded from the headlines, but the problems are still there, with deep structural unemployment and massive debt, both public and private, weighing on the Southern nations. This continues to put pressure on the more prosperous countries in the Union and I am sure I am not the only one with a nagging feeling that there is another shoe that will drop soon.

Secondly, the Bank of England has a seemingly impossible task trying to meet the targets of its dual mandate. Inflation, currently at around 2.8%, is deemed to be too high compared to a target of just above 2%, leading to speculation of a rate rise. This has been one of the major factors in Sterling’s recent short term strength. The problem is that unemployment in the UK, as here in the US, has remained stubbornly elevated at 7.8% versus a stated target below 7.0. Any rise in interest rates could adversely affect that number, so, should there be one, it is likely to be small and couched in temporary language.

Add to that the fact that the UK has a coalition government and the possibility of decisive action one way or another is remote. The most likely scenario is that continued tinkering with monetary policy leaves both indicators short of targets and serves only to confuse the markets.

The UK has a proud history as a major influence on the global economy, and that will no doubt continue in the future. For now, however, I will not be joining the rush to declare the economy healed and invest in the UK. The recent rise in GBP/USD looks to me like a medium term selling opportunity, given the reluctance of global finance to pile back in since the recession, and I would rather be short the FTSE100 than long in the coming months.

Call me a traitor if you will, but experience has taught me to trust what the currency markets say over anything else, particularly any misty-eyed view I may have of my old home.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Forex and Currencies , Economy , Stocks

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