Sterling’s rise could be over

It has been the hero of the forex markets this year, but sterling’s glory days may be over.

The British pound has been strengthening against the euro and especially against the dollar on the back of a strong economy, benign inflation and rising business confidence since last year.

But the trend is likely to halt, if not yet actually reverse, as a series of hurdles appear on the horizon.

The hype around the UK being the fastest-growing major economy this year “conveniently ignores” five years of underperformance before this, Ross Walker, senior UK economist at RBS, said in research published this week.

“This rear view mirror complacency risks underestimating the impact of monetary and fiscal policy tightening in 2015,” he warned.

Official projections put the impact of fiscal tightening at around 1% of GDP next year and at almost 5% of GDP over the four years to 2018-2019.

“Alongside a still-bloated stock of household debt and a subdued wage inflation outlook, this reinforces the likelihood of a lower ‘neutral’ level of policy rates,” Walker said.

RBS analysts see UK interest rates at between 2% and 2.5% over the Bank of England’s three-year forecast timeframe.

A risk that is not yet priced in by the market is political risk. Walker references a quarterly survey of chief financial officers with the biggest companies in the UK by Deloitte, which recently showed political risk overtaking worries about the economy.

Political Risk Tops Worries

Political risk on the rise in the UK

The general elections in May next year are the top risk identified by CFOs, followed by the possibility of a referendum on the UK’s membership of the European Union.

Another survey, recently published by the accountancy think-tank ICAEW, has shown business confidence falling in the third quarter for the first time in two years.

The ICAEW / Grant Thornton UK Business Confidence Index was down to 32.3 in the third quarter from the second quarter’s reading of 37.3, which was the highest since the index started in 2005.

The survey also shows that, while other data point to continuing robustness, growth is levelling off in a number of areas.

Companies’ turnover continues to increase but expectations are that the growth will level off over the next 12 months, and the same goes for profitability.

Investment growth is strong but this, too, is expected to level off over the next year, while inflationary pressures remain modest and cost pressures subdued.

The good news is that job creation in the private sector is likely to continue growing over the next 12 months, with half a million new positions expected to be created.

Salaries are expected to pick up but the growth, albeit above inflation, is likely to be gradual as there is still a lot of slack in the economy.

The ICAEW study shows that virtually all industries still have room for non-inflationary expansion, with nearly 70% of manufacturing and engineering firms saying they operate below spare capacity, followed by production industries and IT and communications.

The property sector, where there has been a housing boom due to the low interest rates, is the industry that has the least spare capacity, with 40% of companies saying they do not operate at full capacity.