LIBOR scandal is a reminder of fundamental GBP weakness
When picking a major western currency to back these days it is very much down to finding the least ugly, rather than the best looking. The US is marred by sub-standard GDP growth (but at least it is still growing), long-term budget deficit worries and a moribund real estate market, whilst the Eurozone is going through an existential crisis and the UK seems to permanently flirt with recession.
The recent scandal over banks in the City of London manipulating LIBOR, a key lending rate, ups the UK's ranking in the ugly stakes as it undermines a key driver of its economy – the financial services sector. Financial services make up about 10% of UK GDP, contribute around 12% to tax receipts and are a major exporter. Other major economies are a lot less reliant on financial services, including the US, which nonetheless hosts the other true global financial centre, New York.
The UK and its out-sized financial services industry was a big beneficiary of the 'nice' decade up to 2007 when favourable economic trends, rising leverage and a more relaxed regulatory regime prevailed and GBP reflected that on the foreign exchange markets.
But the UK is in a very different world now – the global economy is beset by permanent growth and crises concerns and in the West at least, deleveraging is now the order of the day and policy makers are showing an iron determination to clamp down on 'animal spirits' in the financial sector. Another factor is the gradual reversal in cross-border financial services as many international banks refocus on their home markets and this hits London harder than say New York as it is more dependent on the global economy.
Meanwhile, the LIBOR scandal will merely encourage regulators to redouble their efforts and these days much of Britain's regulation comes from Brussels so is outside its control. Most continental European countries hold the City of London in contempt and as they derive a much smaller proportion of their GDP from financial services they have little hesitation in supporting greater financial regulation.
With one of the UK's major industries effectively in long-term decline and with little in the way to replace it in the immediate future, this is likely to have negative consequences for GBP. It is also likely to see the Bank of England pursue unorthodox monetary policies such as quantitative easing more vigorously than other countries. Versus the USD at least, the GBP could eventually drift towards 1.35-1.40. It is much harder to make a call versus the EUR as sentiment swings violently over whether or not it will even exist in a few years time. Of course GBP weakness also depends on just how ugly the situation is elsewhere, but relative to the USD at least, GBP does seem to have more headwinds at the moment.
Forex: UK's financial services sector soared on the back of growing leverage and globalisation and boosted the GBP in the process. This is all going into reverse and the LIBOR rigging scandal is another reminder that the City of London is in long-term decline with negative implications for GBP.
This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities.