Sterling crisis talk increasing

2013-JAN-14

Are the markets at long last taking central banks at their word? This would appear to be the conclusion to draw from the continuing bullish action in stocks and commodities, as well as gold and silver, though there remain any number of black swans circling overhead. The euro and Aussie dollar are gaining while the US dollar is losing ground to other currencies – sure signs of bullish sentiment. No news is good news as far as Europe is concerned, which is the case at the moment. The EURUSD briefly hit $1.34 this morning, its highest level since the end of last March. Gold is bumping up against minor resistance around $1,670-75 while silver is facing selling pressure around $30.75.

Markets are in the sweet spot at the moment, but the inflation demon lurks at the back of people’s minds. It won’t take long for further gains in crude oil to start causing concern, while last year’s drought in the American Midwest (the worst since the 1930s) is causing consistent gains in agricultural commodities. In central banks’ ideal world, quantitative easing would stimulate stock markets, cap bond yields, and lead to positive – yet not excessive – wholesale price gains (say around 4% per annum). Alas, while they can control the amount of base money they create, they cannot control the consequences – and higher commodity prices are an inescapable consequence of devaluing currencies.

Interestingly, it looks as though serious doubts about QE are starting to emerge – tentatively, still – in British financial circles. The Bank of England is the undisputed champion of money printing – having increased its balance sheet by more than 350% since the crisis in late 2008. Yet as Liam Halligan reports in The Sunday Telegraph, despite this massive monetary effort many expect that the UK is sliding into a “triple-dip recession” (in reality, it’s been in depression since 2007, but no one will admit this). Manufacturing contracted in November, while the current account deficit is ballooning: expected at 3.4% of GDP for last year, the largest since 1990.

The widening current account deficit is particularly worrying, as conventional wisdom holds that QE should boost exports by weakening the pound. Suddenly the idea of a sterling crisis doesn’t look so far fetched after all.