British Pound Could Crash in 2016

Where is the GBP to USD exchange rate headed in 2016? That’s the question on my mind, as central banks on both sides of the Atlantic consider raising interest rates for the first time in years. Considering recent data and comments from the Bank of England’s (BoE) Mark Carney, I’d wager the British pound sterling is due for a slump against the dollar in 2016.

That’s not to say the pound will collapse against a larger basket of currencies, but I do think it will depreciate relative to the U.S. dollar. We only have to look as far as the BoE to understand why, especially with the obvious hints Mark Carney has been dropping.

He’s been dropping hints all year that the BoE would start to hike interest rates before the New Year, raising expectations for a strong British pound in 2016. But recent information about British manufacturing may force Carney to postpone till next year. (Source: “Weak growth in UK manufacturing poses Bank of England dilemma, ” The Guardian, December 7, 2015.)

Here’s why…

Oil and Export Concerns Underlie British Pound

Last year’s sudden drop in oil prices has decimated production along England’s northern coastline. The problem was compounded by the British pound gaining against the euro, prompting four quarters of slowing export growth.

All in all, the timing is bad for a rate hike and timing is everything in monetary policy.

For instance, the Federal Reserve has been ramping up expectations of a rate hike this month, so investors adjusted prices accordingly. The 30-day Fed Fund Futures shows that the market predicts an 83.3% probability of a rate hike. (Source: “CME Group FedWatch, ” CME Group, last accessed December 8, 2015.)

Assuming that the Fed follows through and actually does raise interest rates, it won’t come as a shock to many. Markets might take a little stumble as the Fed withdraws its support, but things would soon balance out. The move would be appropriately timed.

Mark Carney knows the BoE isn’t in the same place as the Fed, which is why he’s singing a different tune these days. From his recent statements, I don’t expect any big policy changes at the BoE meeting on Thursday, December 10.

The importance of a central banker’s words is not to be underestimated. Heck, if Janet Yellen so much as sneezes, the Dow Jones Industrial Average could fall 100 points.

Kidding aside, Mark Carney is someone investors watch closely and there’s been a substantial shift in his tone over the last few months. It now looks like the BoE will wait until 2016 to raise interest rates. Although pushing the rate hike by a few months doesn’t seem like a big deal, it actually has enormous implications for the GBP to USD exchange rate.

Higher interest rates would draw in capital to the United States, strengthening the U.S. dollar. By contrast, the Fed’s move would hurt the GBP to USD exchange rate, giving a much-needed boost to British manufacturing.

Using a Weak Pound Sterling to Its Advantage

Mark Carney could salvage the situation by waiting, which is exactly what he seems to be doing. Once the Fed raises its rates and the USD to GBP exchange rate plummets, British exports could see a resurgence.

British consumers won’t be too happy about it, but Carney understands that a lower rate could pump some life into struggling manufacturers. Then, once the momentum is back in his favor, Carney will finally be ready to raise rates in England.

Until that happens, it seems obvious the British pound must suffer a decline against the dollar.

Courtesy of Profit Confidential, by Gaurav S. Iyer