Pound Favored as Haven Currency Amid Europe Debt Crisis

Pound Wins Least-Ugly Contest in Europe as Franc Haven Lost
A U.K. one pound coin sits on a ten pound note, arranged for a photograph in London. Photographer: Chris Ratcliffe/Bloomberg

The British pound has become currency traders’ favorite refuge from the resurgent European debt crisis, threatening efforts by U.K. Prime Minister David Cameron to lift the economy out of its second recession in three years.

Sterling has appreciated 4 percent this year, the most among 10 developed-market peers, data compiled by Bloomberg show. Strategists have boosted their year-end forecasts for the pound against the euro by 3.6 percent in 2012, while options show investors are becoming more positive on the pound versus its 17-member European counterpart.

Bulls say the pound’s 8 percent advance against the euro since the end of October, even as the Bank of England flooded the financial system with sterling, is a sign the economy has bottomed. Bears say the gains may prove fleeting because the strong pound makes exports less competitive in the euro region, which buys about 47 percent of the U.K.’s overseas sales.

“The U.K. economic backdrop may not be brilliant, but it’s enjoying a haven status because of the political uncertainty in the euro zone,” Ian Stannard, head of European currency strategy at Morgan Stanley in London, said in a telephone interview on May 8. “The advantage of sterling over a traditional haven like the Swiss franc is that its asset market is more liquid. The downside is that the strength of the pound may backfire as it hurts exports.”

Swiss Franc

Switzerland was the top choice for investors seeking safety from global financial and political turmoil, driving the franc to 1.0080 per euro in August from 1.6828 in 2007. The Swiss National Bank then said on Sept. 6 it wouldn’t allow its currency to appreciate beyond 1.20 per euro. Since then, the franc has traded between 1.2474 and 1.1990.

That leaves the pound, which accounted for twice the daily trading volume in the foreign-exchange market of the Swiss currency in 2010 based on Bank for International Settlements data, as the best alternative.

The pound strengthened 0.7 percent to 79.84 pence per euro at 3:36 p.m. in London as Greece struggled to form a government after inconclusive May 6 elections. Sterling was little changed versus the dollar at $1.6090 after the Bank of England last week halted its quantitative-easing, or QE, program at 325 billion pounds amid the threat of inflation.

The U.K. economy fell into its second recession since 2009 in the first quarter amid Cameron’s spending cuts, the deepest fiscal squeeze since World War II. The double-dip contraction is the first since 1975.

‘More Anxiety’

Growth will return over the full year, with gross domestic product rising 0.6 percent, according to the median of 24 economist estimates compiled by Bloomberg. The euro area will shrink 0.3 percent in 2012, a separate Bloomberg survey showed, as recessions grip no fewer than five countries from Greece to the Netherlands.

“There has been a lot more anxiety about what’s been going on in Europe recently than there has in the U.K.,” Jeffrey Molitor, chief investment officer for Europe at Vanguard Group, which has about $1.7 trillion of assets under management, said in an interview on May 8. “Britain is attractive because it has a relatively stable government, an intelligent workforce and an economy that can grow.”

Forecasts Raised

The pound will end the year at 81 pence per euro, according to the median estimate of 42 analyst forecasts compiled by Bloomberg. On Dec. 31, analysts were forecasting sterling would weaken in 2012, to 84 pence from 83.34 pence. The U.K. currency will end the year at $1.59, another survey shows, up from a prediction of $1.56. The pound has averaged 72.26 pence per euro since the common European currency was introduced in 1999, with the dollar averaging $1.2081 versus the euro in the period.

Barclays Plc raised its three-month forecast for the pound on April 23 to 79 pence per euro from 84 pence, citing “sticky” inflation preventing the Bank of England from loosening monetary policy. Royal Bank of Canada strategist Elsa Lignos said sterling will strengthen to 77 pence by the second quarter of 2013, from a previous forecast of 79 pence.

“We expect the pound to be one of 2012’s outperformers, with an overall positive uptrend,” London-based Lignos wrote in a May 10 investor report.

Cameron is sticking to the austerity program pledged when he came to the office two years ago, ending 13 years of Labour rule. He told the House of Commons on May 9 that deficit reduction is needed to keep interest rates low.

Cameron’s Cuts

His program includes at least 80 billion pounds of spending cuts to eliminate a deficit totaling 8 percent of gross domestic product by 2017. The reductions will result in 700,000 public sector job losses and lower spending on programs ranging from education to health care.

Standard & Poor’s affirmed Britain’s AAA rating and stable outlook on April 13, saying Cameron will maintain his focus on closing the budget gap.

U.K. output is about 4 percent below a pre-recession peak reached in 2008 and unemployment at 8.3 percent was close to a 16-year high in the three months through February, the Office for National Statistics reported on April 18, using International Labour Organization methods.

The economy grew 0.1 percent in the three months through April and will remain flat the next six months, the National Institute of Economic and Social Research said May 10 in London.

Inflation Risks

The Bank of England halted its so-called quantitative-easing program the same day amid rising inflation risks. Consumer-price growth has been above the government’s 2 percent target since December 2009. Policy makers kept their benchmark interest rate at a record low 0.5 percent.

The boost the pound has received by putting QE on hold in the recession will probably be short-lived because the economy remains weak, according to Paul Meggyesi, managing director and currency strategist at JPMorgan Chase & Co. in London.

“It’s an impressive blip, but it’s still a blip,” Meggyesi said in a telephone interview on May 11. “I’m not sure the Bank of England has the luxury of sitting on the sideline watching while the economy continues to stagnate. The economic foundations, or the growth foundations, of sterling strength are not that compelling.”

Pound ‘Problem’

An appreciating currency may impose additional hardships on U.K. companies.

“A stronger pound at a time when domestic demand is being affected by the austerity measures is a problem,” British Chambers of Commerce Chief Economist David Kern said in a May 11 telephone interview. “It hasn’t reached dimensions yet that require immediate counteraction but it needs to be watched as it can cause a problem for exporters.”

Sensor Technology Ltd., a Banbury, Oxfordshire-based maker of torque sensors, which sells to companies including GlaxoSmithKline Plc, sends about 25 percent of its exports to Europe, said Tony Ingham, one of the three owners of the closely held company.

“If the exchange rate changes markedly then we obviously have to change the price that we sell at,” Ingham said in a May 11 telephone interview. “We will have to look very carefully at the euro rate,” even as the company hasn’t adjusted its prices yet, he said.

The pound is no Swiss franc in terms of national economic fundamentals. Britain’s gross public debt to GDP ratio will rise about 6 percentage points this year to 88.4 percent, according to an International Monetary Fund forecast. Switzerland’s debt will be 49 percent, and its budget surplus will extend through next year, an IMF report showed on May 8.

Political Impasse

The euro tumbled to a more than three-month low versus the dollar today as Greek political leaders struggled to form a government after inconclusive May 6 elections raised the possibility another vote will have to be held. The standoff reignited European concern over the nation holding to the terms of its two bailouts negotiated since May 2010, and sparked speculation about the country leaving the currency bloc.

Fifty-seven percent of investors said at least one country will abandon the euro by year-end, according to a Bloomberg Global Poll published May 10.

“Sovereign debt bloat and austerity resistance are undermining the euro,” said Clem Chambers, chief executive officer at financial website provider ADVFN.com. “It’s thus little wonder the currency has reached the low against the pound not seen for three and a half years.”

Socialist President

Francois Hollande, who defeated French President Nicolas Sarkozy to become the first Socialist in 17 years to control Europe’s second-biggest economy, has said he’ll push for less austerity and more growth in the region. Hollande has advocated more aggressive measures to spur economies, putting him at odds with German Chancellor Angela Merkel, who opposes adding to nations’ debt burdens.

The premium for three-month options granting the right to sell the euro against the pound relative to those allowing for purchases reached 1.84 percentage points today, the most this year. It’s up from 0.59 percentage point in January, the 25-delta risk reversal rate shows.

“In an ugly bug ball, the pound is not quite as ugly as the rest of them,” said Alan Brown, a special advisor in London at Schroders Plc, which has $319 billion in assets under management. “The pound is one of our favorite currencies at the moment. That’s a tactical view, although it may probably last for a while.”