Sterling caught in a 'quiet crisis’

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As markets bet against the pound, 2013 could be a tipping point for the currency.

Of all the challenges facing Mark Carney when he swaps the keys of 234 Wellington Street, Ottawa, for the “Old Lady” of Threadneedle Street , the very real crisis facing sterling will be one of the things at the top of his agenda.

Although conflicting voices will attempt to influence the strategy he follows in his first months as Governor of the Bank of England, Sir Mervyn King’s successor could do worse than listen to the man who infamously almost “broke” the Bank two decades ago.

George Soros who made £1bn from betting against sterling in the spring of 1992, pushing the UK out of the European exchange rate mechanism cautioned that the markets are betting against the pound.

Asked at a dinner at the World Economic Forum in Davos whether he would once again bet against the pound, he replied: “The markets are.” Mr Soros said the UK was in the perfect position at present as a member of the European Union, but not a member of the eurozone.

He added austerity was the “wrong policy at this time”, but quantitative easing (QE) was the right policy: “You can only grow your way out of excessive debt. You can’t shrink your way out of it.”

However, he argued that just like the Federal Reserve in the US, the Bank is effectively devaluing its currency in order to deliberately increase exports and create growth. As the European Central Bank has stopped short of quantitative easing, so the euro will remain higher.

But while some may view a weak pound as a necessary by-product of current monetary policy, investors are cautioning that the situation is far more than just a short-term blip.

Stewart Cowley, head of fixed income at Old Mutual Global Investors, is one of the City’s leading bond managers. He manages the firm’s £875m global strategic bond fund, which consistently outperforms its competitors.

Cowley is less forgiving than Soros. In the four months since September, The Sunday Telegraph can disclose for the first time that Cowley has gone from having 90pc of his fund invested in sterling to less than 50pc today. Of the remainder, 35pc is in European currencies, including the euro, the Swedish kroner and the Danish kroner, and the rest in commodity-related currencies.

In the four years he has been running the fund Cowley has managed bonds since the early 1990s, including stints at Invesco (NYSE: IVZ - news) , Hill Samuel and BNY it is the lowest sterling position he has held.

For Cowley, one of the top-rated bond investors in the Square Mile, his decision is as much about what is happening elsewhere as a significant change of affection for sterling. “The pound has got away with this over the past year because of what it isn’t it isn’t the euro, it isn’t the dollar,” he says, to explain why he invested in sterling last year.

He says that with the euro rarely out of the headlines as a result of the crisis in the eurozone, and the dollar out of favour due to the problems of America’s growing debt pile, sterling was a safe haven.

But since September, he continues, as the ECB has begun to manage the crisis, and sterling began to fall against the euro, as sentiment shifted. “I call the pound the dollar of Europe as we’re pretty much as bad as the Americans,” he says as he criticises the Government for the impact its policies are having on sterling.

“The Coalition has done precious little to touch that deficit. That is bad for your currency ultimately.”

Cowley is also critical of the impact of the Bank’s QE programme.

“We’ve been indulging ourselves in a process of QE, which has created £375bn of electronic money running around our society with a sense there are no consequences. In simple economic terms, if you create more of something people don’t want, the price goes down,” he continues.

The outcome he warns, could be problematic for Carney early in his five-year term.

“It’s very easy to foresee a sterling crisis. What we’ve got now is a quiet crisis going on every single day,” Cowley warns.

He is not alone. David Bloom, HSBC’s global head of foreign exchange strategy, warns that the pound will “lose the ugly contest” in 2013.

“2012 was dominated by three key issues for markets, the eurozone crisis, the US fiscal cliff and fears of a Chinese hard landing,” argues Bloom.

“The issue of a eurozone break-up is now off the agenda, as is a Chinese hard landing. Meanwhile, for the moment, the US has stepped back from the fiscal cliff. The UK’s failings are now more likely to grab attention.” Bloom believes that sterling “looks vulnerable,” with 2013 seen as a tipping point. It could be the time when sterling’s impervious nature to unhelpful economic news will begin to change.

That tipping point will be the result of weak growth and deepening austerity measures and the real threat of a downgrade to the UK’s cherished AAA credit rating.

But Bloom, like Cowley, believes that QE could now have a negative effect on sterling.

“QE has been neutral for the currency as the loosening of monetary policy was seen as an appropriate offset to the ongoing tightening in fiscal policy,” he says.

“With the pain of austerity now kicking in at a time when the MPC (KOSDAQ: 050540.KQ - news) appears less activist, the happy cohabitation of tight fiscal and loose monetary policy will be challenged, and GBP [sterling] with it.”

The arguments of the two men are backed up by data from the wider market. The US Commodity Futures Trading Commission (CFTC (Taiwan OTC: 1586.TWO - news) ) publishes weekly positions on a number of investment types from US investors, including currencies. The latest report shows speculators have trimmed long positions in sterling in recent weeks, a marked change from the position at the height of the euro crisis.

Such sentiment is clearly reflected in sterling’s current position against other major currencies. The pound declined for a fourth week against the euro in the week just ended, its longest downward streak since September. At one point on Friday the pound touched 87.17p against the euro, its lowest level since October 2011.

Of the 10 developed world currencies tracked by Bloomberg through its correlated weighted indexes, the pound is the second worst performer so far this year behind the yen.

Sterling is at a 15-month low against the euro which is damaging to the German economy’s trade balance, much to the irritation of Chancellor Angela Merkel, who is also being affected by a weakening yen.

“The UK economy is in shambles and, with a new central bank governor looking like turning on the tap to support growth, we expect the pound to underperform, both against the dollar and on a trade-weighted basis,” said Ned Rumpeltin, currency strategist at Standard Chartered (Other OTC: SCBFF - news) . “Given higher inflation and lack of growth, who would want to buy the currency?”

Although Carney’s focus on growth at Davos may have given a hint as to his own personal priorities, it may be the case that events in the currency markets require his attention far sooner than he had envisaged.