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How much further could sterling fall?

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How much further could sterling fall?

Sterling has fallen by more than 3% since the middle of July, dropping from a six-year high of $1.71 to $1.65, as UK data revealed wage growth had hit a record low.

Such was the seemingly inexorable pace of its earlier rise, up by 10% in 2014 versus a basket of currencies, the fall only took it back to its late-May value. 

The rate of the decline accelerated sharply last week after the Bank of England halved its forecast for 2014 wage growth from 2.5% to 1.25%, dropping two US cents overnight, leaving it teetering on the edge of some significant technical support levels.

‘Carney’s dovish tone will likely continue to encourage bearish movement in the GBP/USD for the time being,’ said Jameel Ahmad, chief market analyst at broker FXTM. He added that the inflation report had been ‘the bull’s last throw of the dice’ on sterling for the foreseeable future.

In particular following this week’s falls the pound has just dropped below its 200-day moving average, which has historically proved a reliable indicator that GBP/USD is about to hit an air pocket.

 

In the 10 times the pound has dropped beneath its 200-day moving average versus the dollar since 1999 it has on average dropped by more than 11% further before finding solid ground. While that includes sterling’s 45% devaluation in 2008/09, removing that from the equation does not make the picture look much prettier, with an average fall of 7.4%. 

Across those occasions, the majority of the peak-to-bottom losses occurred after two lines crossed, with an average of 66% of losses occurring below the moving average. If history is a useful guide, that would imply a support at $1.52.

That remains unlikely according to the majority of the 20 leading FX forecasters tracked by Reuters (although some way above the most bearish forecast in the sample at $1.35), with both the forward contract and the median view converging over 12 months at $1.66.

Part of the dislocation that may cloud the picture of the relative value of sterling is caused by the policy backdrop of targeted and competitive downward manipulation of FX rates.

Versus a basket of currencies and the dollar, sterling has risen by 21% and 24%, respectively, from 2009 to the recent high. The real effective exchange rate, which is weighted toward the currencies of the economy’s main trading partners, tells a different story, rising by 19%.  

From the 2008 high, the real effective exchange rate, which is 66% weighted to the eurozone, remains just 11% down versus 18% on the GBP/USD. So isolating the USD cross may provide an exaggerated view of both the pound’s relative value and its longer-term range of movement.

Increased volatility has also played a part as investors pulled back from higher-yielding securities for the relative security of dollar denomination. 

In a research note published as sterling was tumbling last week, so not integrating the steepest period of declines, Bank of America Merrill Lynch UK FX strategist Athanasios Vamvakidis estimated that around 0.75% of sterling’s losses against the dollar could be attributed to risk aversion.

‘G10 FX trends during the recent market correction could provide insights on possible moves during a more severe adjustment,’ he said.

While all G10 currencies lost value versus the dollar, within the group sterling proved a relative beneficiary, with currencies such as the Australian and Canadian dollars and Swedish krona losing around 2% versus the USD over the same period.

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