Binary bet of the week: The Puzzle Of The Pound

by Dave Evans of binary.com

Since taking over the stewardship of the Bank of England, governor Mark Carney has not had a smooth ride. Forward guidance has been wide of the mark, with interest rate guidance slipping quickly between bullish and dovish from month to month. In defence of Carney, he has continually stated that policy decisions will be data driven. The problem is that the data keeps on springing surprises.

The puzzle for the MPC is that while the economy is improving and unemployment dropping, wage growth is stubbornly dripping lower.

UK GDP 2nd estimate Q/Q

UK GDP has been on a strong run for over a year with one of the strongest growth rates in the Western world.

UK Unemployment Claims M/M

At the same time, UK unemployment claims have dropped steadily month on month.

UK wage growth:

The final piece of the puzzle is the steady drop in average UK earnings. How can there be such a strong recovery while wages are dropping in real terms?

One explanation is that loss of relative earnings from creeping inflation has less of a psychological impact than a general feeling of an economy that is growing. We are buying more items and providing more services to each other, but this is not translating into higher take home pay.

Perhaps after soaring growth in the 90s, living standards have generally reached a point where the majority of people can get by without rapid pay increases provided there is work around.

Whatever the answer, the lack of wage growth is a major consideration in the Bank of England’s interest rate policies. The latest guidance appeared to kick a rate hike even further into the long grass, but that was this month – next month who knows.
Over the last six weeks, the interest rate balance has certainly tipped back towards the dovish end of the spectrum, sending the GBP/ USD and EUR/ GBP shooting lower.

GBP/ USD weekly chart:

The GBP/ USD chart shows how the last few weeks have rapidly reversed the pound’s advance.

EUR/ GBP Weekly Chart

While the EUR/ GBP has also switched course, the move has not been as dramatic due to the weakening German economy.

It is this consideration that brings up potential trading angle.

There is no doubting that UK interest rate speculation became too overheated, with recent weeks providing a much needed realty check. The question now is whether the pound has found parity of if it has further to fall. Against the dollar, there may indeed be further to go until the dollar index weakens for the first time in weeks.

Against the euro however, there could be room for the pound to regain some ground.

While UK interest rate speculation has reversed course, so too has the German economy at the centre of the Eurozone.

German ZEW Economic Sentiment

Economic sentiment in Germany has hit reverse gear with eight consecutive months of below expectation reports. Europe managed to paper of the 2010 crisis cracks, but the fault lines still remain. In addition, it seems that the Russian sanctions may be having an impact on Germany which itself is not feeling the effects of austerity politics.

Even if the British pound were to stand still from here, there’s a strong likelihood of further weakness in the euro, which makes a downside trade attractive here.

A good way to play this is a LOWER trade predicting that the EUR/ GBP will close below  0.8000 in 60 days time for a potential return of 129%. Or put another way, betting that the EUR/ GBP will be below 0.8000 at the close on October 14th could return £16.52 from a £10 stake.

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