What's to love about the British pound (GBP)? Not much. The U.K. has an economy that can't recover for any length of time, credit rating downgrades are almost a dead certainty and worst of all there's a risk of a vicious downward spiral if investors lose confidence.
If it wasn't for the fact that much of the rest of the world looks pretty bleak, there probably would have been a run on GBP a while ago. Such are the scale of the U.K.'s economic woes that GBP may now replace JPY as the dog currency on forex markets over the coming months.
It is quite possible that GBP/USD will be test support around 1.5400-1.5350, levels last seen in the Summer of 2012. Over the longer-term, if few improvements show up, GBP/USD could even break through 1.4000, last pierced in 2009. Worryingly for GBP the current risk-off rally driving equity markets seems to have passed it by completely despite being seen as a 'risk' currency. The next catalyst for GBP/USD could come as early as Friday, Feb. 1 with the release of U.S. non-farm payrolls. A good number is likely to be bullish for the U.S. dollar.
Q4 U.K. GDP actually fell 0.3% and there are a number of technical arguments to suggest the decline isn't as bad as it looks, but overall 2012 was a weak year for the British economy as have been the last five years. But, a weak domestic economy often is compensated by a fall in the value of the currency — that's happened in the UK with declines of 25%-30% — followed by a pick-up in exports and less imports. That rebalancing hasn't happened and the U.K.'s current account deficit is now around 3.5% of GDP, compared with 1.3% in 2011.
So in effect trade is subtracting from the U.K. economy and if the current account deficit carries on worsening, not only will it weigh on growth, but it is bound to have a depressing impact on GBP. A lower GBP also will feed inflation via energy and food imports, so would further dent already hard pressed consumers with earnings growth around 1.5% and inflation at about 2.7%. And going by recent form, there probably won't be any dramatic pick-up in exports on GBP weakness either, though it should provide some help.