David Shairp from Prudential Portfolio Management Group (PPMG), shares his analysis of key economic events in the latest PPMG economic update.
This week, David ponders what will stabilise the pound?
“One of the natural circuit breakers is valuation, which should act to support any asset that becomes extremely oversold and thus significantly undervalued. Currency valuation is notoriously difficult, but looking at the real effective exchange rate, the pound was 15% down from year-ago levels at the end of September, equivalent to 1.9 standard deviations (SDs) below its five-year average.
“We estimate that since the end of last month the currency is now -2 SDs using the five-year average. There have been only five previous occasions this level has been breached in the past 40 years (in 1985, 1992, 2003, 2006 and 2007/09). The most extreme example was 2008, when sterling fell 4 standard deviations below its five-year average. An equivalent move this time would imply a rate below $1.20.
“Monetary policy is not likely to be supportive. The default policy response has been more monetary easing (QE) which is now being written off as less effective.
“The Bank of England governor, Mark Carney, has been proactive thus far, which has probably helped to put a positive spin on the economic survey data post referendum. But any further measures from the BoE, to do whatever it takes to keep growth supported, would be likely to place further downward pressure on the currency.”