Pound’s August Gain to Franc Proving Too Much: Market Reversal

Photographer: Chris Ratcliffe/Bloomberg

The pound has climbed 3 percent in August versus a basket of 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes, the biggest monthly gain since September 2011, as unemployment claims dropped more in July than economists forecast. Close

The pound has climbed 3 percent in August versus a basket of 10 developed-market... Read More

Close
Open
Photographer: Chris Ratcliffe/Bloomberg

The pound has climbed 3 percent in August versus a basket of 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes, the biggest monthly gain since September 2011, as unemployment claims dropped more in July than economists forecast.

The British pound is reversing its best monthly gain in a year against the Swiss franc as trading patterns suggest its rise was too much, too soon.

Sterling advanced last week to a more than two-month high of 1.4592 francs, breaching the upper boundary of its 20-day Bollinger band and signaling that the pair had overreached. Options traders were paying the highest premium in almost six months to buy the pound versus the franc on Aug. 16, also setting it up for a U-turn, 25-delta risk reversal rates show.

“We’re definitely catching some pretty critical levels -- a solid resistance zone,” said Chris Tevere, a senior currency strategist and chartered market technician at Gain Capital Group LLC in New York. “This is the kind of make-or-break level where, if people think sterling is too strong, they might try to fade it.”

The pound has climbed 3.7 percent in August versus a basket of 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes, the biggest monthly gain since January 2009, as unemployment claims dropped more in July than economists forecast. Sterling bears view the data strength as temporary, with the Bank of England remaining prepared to loosen monetary policy.

Carney Effect

BOE Governor Mark Carney took the unprecedented step earlier this month of saying the central bank probably won’t raise its benchmark interest rate from a record-low 0.5 percent until unemployment falls to 7 percent, pressuring the currency.

Carney’s dovish guidance did little to slow an increase in the pound. Sterling has climbed 1.4 percent against the dollar since the comments on Aug. 7, the biggest gain among 16 major peers tracked by Bloomberg, and rose 0.5 percent versus Switzerland’s currency, to 1.4444 francs as of 12:36 p.m. in New York. The pound’s 2.6 percent gain versus the franc in August is the most on a monthly basis since July 2012.

“The Bank of England is likely to reiterate in the future that it still has options open to keep monetary policy very loose, cut rates or even do quantitative easing if required,” Michael Sneyd, a currency strategist at BNP Paribas SA in London, said in an Aug. 15 phone interview.

The British currency has been testing the upper limit of its 20-day Bollinger band versus the franc since breaking it on Aug. 15. The measures, developed by John Bollinger in the 1980s, are used by technical analysts to identify the turning point in an asset’s trajectory.

‘Too Extreme’

Options traders were paying a 0.37 percent premium to buy the pound against the franc on a three-month basis as recently as Aug. 16. That was the largest premium since June 27 and suggested that bearish bets on the currency pair may have been overextended.

“Sterling’s rise looks far too extreme, so we expect some unwind of the overvaluation of the pound,” BNP’s Sneyd said. “We would expect a decline as investors unwind some of that over-optimism that they’ve priced into the currency.”

The pound’s advance hasn’t dissuaded foreign-exchange strategists, who for the first time since June are boosting their outlook for sterling against the euro as conviction grows that U.K. economic growth will outstrip that of continental Europe. Futures traders last week also added the most bets in more than a year that European rates will rise more slowly than those in the U.K.

Surprise Index

Britain’s unemployment rate remained at 7.8 percent in the second quarter, while jobless claims declined by 29,200 in July to 1.44 million, twice as fast as predicted by economists, the Office for National Statistics said Aug. 14.

Citigroup Inc.’s Economic Surprise Index for the U.K. climbed to 113.3 on Aug. 19, the highest level since October based on end-of-month values, and more than double the reading for the euro region.

“The data has been very supportive for sterling,” Mike Moran, a senior currency strategist at Standard Chartered Plc in New York, said in an Aug. 15 phone interview. “It’s been much stronger than the market gave it credit for.”

As economic data improve, the U.K. still must rely on capital from money markets to compensate for its existing trade gap, according to Morgan Stanley’s Hans Redeker. A stronger pound jeopardizes these inflows by making the U.K. more vulnerable to a potential depreciation in the currency, he said.

International Monetary Fund data show the U.K. currently has a current-account deficit of 4.3 percent of gross domestic product. Germany has a surplus of 5.7 percent.

“Money markets only come in if they think sterling is trading at a low enough level to protect them against potential currency losses,” Redeker, the London-based head of global foreign-exchange strategy at Morgan Stanley, said in an Aug. 15 phone interview. “They fear money-market flows are not going to come in, so we could see sterling back under selling pressure.”

To contact the reporter on this story: Joseph Ciolli in New York at jciolli@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.