Currency Watch: Mervyn cuts a sombre figure

There are few things that we can say with confidence when it comes to FX markets, especially when trying to anticipate market movements.

However, one that we can more readily predict, is that every time Mervyn King takes to the stand, GBP dies a little inside and this week was no different.

GBP dropped as he entered the room to deliver his views on the path ahead for the UK’s economy, perhaps the markets didn’t care for his choice of tie.

Having watched the press conference, one thing I did notice was the choice of language used to describe the UK’s outlook. The use of words like “sustained”, “persistent”, “subdued”, were all used in reference to low and negative growth.

While in the past we have had to listen to politicians and economists throw in their two cents as to the state of the economy, there was a real sense of prolonged pain and deterioration in King’s words.

He stood behind the validity and effectiveness of the QE programme, confirming that it was still his weapon of choice to combat the threat of recession. He was clear to point out that the success of QE was down to timing and not quantity. The appreciation of the pound and an “unfavourable external environment” – in the Eurozone in particular, were the main culprits for causing the UK difficulties.

In a nutshell – the future looks grim and the UK isn’t going to be pulling itself out of this hole anytime soon, with a Q4 contraction now likely. GBP/USD and GBP/EUR dropped to a new 11 week and three week low respectively following this appraisal.

Minutes from the last Fed meeting were also released this week, which highlighted the plans to support its QE programme by extending Operation Twist.

As expected the Fed and its monetary tool belt will take a back seat while the ‘fiscal cliff’ is tackled by the government. Obama gave a speech yesterday stating that the government was making good progress in undertaking policy changes.

US retail sales were slightly worse than expected for October due to Hurricane Sandy, but this isn’t the big issue which people are thinking about across the pond. If the US politicians can’t find a way to resolve the problems of the “fiscal cliff” it won’t just be a bad thing for the Americans.

King might find himself expressing an even more sombre tone if the US doesn’t avoid falling over the edge.

John Daly is an economist at World First foreign exchange.