BNP, UBS, Pounded by Forecast, Are Proving Prescient (Update3)
BNP, UBS, Pounded by Forecast, Are Proving Prescient (Update3)
By Gavin Finch and Bo Nielsen
Sept. 24 (Bloomberg) — The world’s three biggest currency traders advised investors at the start of the year to bet against the British pound when it traded at $1.9588. Instead, it climbed to a 26-year high of $2.0654 on July 24, a gain of 5.4 percent.
The bears at Frankfurt-based Deutsche Bank AG, UBS AG in Zurich and Citigroup Inc. of New York may yet be vindicated as the U.S. subprime mortgage contagion spreads around the globe.
Last week the pound fell to as low as $1.9881 after Britain bailed out mortgage bank Northern Rock Plc. The rescue raised concern that more lenders may seek emergency funding and prompt the Bank of England to cut interest rates, hurting the pound by reducing the relative attractiveness of U.K. debt investments.
“This is an important turning point for the pound,” said Jim McCormick, London-based global head of currency strategy at Lehman Brothers Holdings Inc., the largest U.S. underwriter of mortgage-backed bonds. “The expectations around the economy and monetary policy on the back of what has happened to Northern Rock have shifted pretty significantly.”
Against the euro, the currency fell to a 17-month low of 70.053 pence last week. The Bank of England’s Sterling Effective Rate Index, measuring the pound against 43 countries that trade with Britain, is the lowest in a year. The pound traded at $2.0229 at 3:17 p.m. in London today.
`Turn for the Worse’
Deutsche Bank and UBS say the pound will weaken 6 percent over the next three quarters. Citigroup expects a decline of about 1.5 percent by year-end. Strategists at the firms predicted in December it would trade at $1.96 or lower this year.
Paris-based BNP Paribas SA, which said in June the currency would trade at $1.88 by year-end, is even more bearish, predicting it will fall closer to $1.547 next year, as suggested by the bank’s purchasing-power parity calculations. Lehman forecasts the pound will fall to $1.85 in 2008.
“The outlook for sterling took a turn for the worse after the Northern Rock crisis, which has undermined investor confidence in the housing market,” said Hans Guenter Redeker, head of currency strategy at BNP in London. “Sterling is highly correlated to the housing market.”
Record high delinquencies on mortgages to U.S. homeowners with poor credit have caused lenders around the world to push up borrowing costs, sending three-month dollar Libor to the highest since January 2001, and prompting the Federal Reserve to lower rates for the first time in four years last week.
In the U.K., soaring credit costs led Northern Rock, which relies on the capital markets for 73 percent of its funds, to seek emergency financing from the Bank of England.
Customer Lines
Customers of the Newcastle-based mortgage lender this month lined up at its branches to withdraw their savings, the first bank run in the U.K. since the 19th century, according to London- based Barclays Plc.
Northern Rock has plummeted 70 percent since Sept. 13 in London, while competitors Leicester-based Alliance and Leicester Plc and Bingley-based Bradford & Bingley Plc, which rely on financial markets for more than 50 percent of mortgage funding, have also declined.
Bank of England Governor Mervyn King on Sept. 20 defended his handling of the bailout. He told a parliamentary committee in London that U.K. and European Union laws hampered the central bank’s ability to prevent the worst banking crisis since 1973.
“We’ve seen confidence in King erode,” said David Watt, a senior currency strategist with Royal Bank of Canada in Toronto. “He hasn’t handled the crisis well. If there’s uncertainty about the decisions of the BOE, it erodes confidence in the pound.”
Watt said Royal Bank, which predicts the pound will trade at $2.03 in the first quarter of 2008, plans to cut its forecast next month.
`Most Sensitive’
A decline in the financial industry, which accounts for 10 percent of Britain’s gross domestic product, may slow the U.K.’s economic expansion. Growth may decelerate to 2.2 percent next year, the Confederation of British Industry said Sept. 20, cutting its prediction from 2.4 percent.
“The U.K. economy is one of the most sensitive to the ebb and flow of financial markets,” said Kamal Sharma, a London- based currency strategist at Bank of America Corp. in Charlotte, North Carolina. “Any downturn in the global financial sector is going to hit the U.K. disproportionately hard.”
The pound will fall to $1.91 by April, Sharma said. He cut his forecast for the currency from $1.95 on Sept. 17.
Consumer spending is holding up. Retail sales rose 0.6 percent last month, National Statistics said Sept. 20. Sales were expected to remain unchanged, the median of 31 estimates in a Bloomberg News survey showed. Money supply grew 13.5 percent, the most since May and a sign inflation may accelerate.
Rate Outlook
“There is still lots of evidence of a growing economy,” said Camilla Sutton, co-head of currency strategy at Scotia Capital Inc. in Toronto. The firm forecasts the pound will strengthen to 2.05 versus the dollar by the end of March.
The Bank of England’s benchmark rate, now at 5.75 percent after five rate increases since July 2006, is the highest of the Group of Seven most-industrialized nations. The U.S. Federal Reserve last week slashed its target for overnight lending between banks by half a percentage point to 4.75 percent.
Interest-rate futures show traders expect the U.K. central bank may follow the Fed in lowering borrowing costs next year. Two weeks ago they bet it would raise rates.
The yield on the March 2008 futures contract has fallen 43 basis points to 5.76 percent since Sept. 4. The contracts settle at the three-month London interbank offered rate for the pound, which has averaged about 15 basis points, or 0.15 percentage point, more than the central bank’s benchmark in the past decade. Consumer prices rose less than the government’s 2 percent target in August for a second month.
Barclays Cuts
“The likelihood of the Bank of England cutting rates has clearly increased a great deal,” said Paul Robinson, a senior sterling strategist in London at Barclays Capital in London and a former Bank of England economist. “We previously thought the BOE would raise rates.” Barclays expects the pound to decline to $1.92 in a year, compared with its prior forecast of $1.96.
Investors are covering wrong-way bets on the pound after Northern Rock, the third-largest U.K. mortgage lender by gross loans, sought emergency funds from the central bank on Sept. 14. Risk-reversal rates, the price traders pay to buy options that protect against losses in the event of a drop in the pound, were minus 0.6 percent on Sept. 19, the biggest premium since at least October 2003, data compiled by Bloomberg show.
And while retail sales rose last month, housing prices fell. U.K. home values declined 2.6 percent this month from August, according to Rightmove Plc, Britain’s biggest real-estate Web site. In London, prices tumbled 2.5 percent to 384,439 pounds ($774,000), the biggest drop since 2004.
“The U.K. economy is housing-dominated,” said Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California. “They have had their own housing bubble, and the central bank will have to lower interest rates to salvage that situation. I’ve sold my pound sterling based on that hazardous situation in the U.K.”
To contact the reporters on this story: Gavin Finch in London at gfinch@bloomberg.net ; Bo Nielsen in New York at bnielsen4@bloomberg.net
Last Updated: September 24, 2007 10:17 EDT
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