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Fundamental analysis of the British pound

GBPpoundTrading the British pound has lately involved the need for a very skilled understanding of the stiff Bank of England and its new governor, Mark Carney. 


Carney had been expected to increase the size of the BOE's assets, by buying bonds, and therefore increasing money supply.  GBPUSD bears were looking forward to GBP weakness once Carney took office, as such bond buying would weaken the currency.  This theory brought GBPUSD down to nearly 1.4800 in early July 2013. However since then the cable has been ticking up, and is currently sitting at about 1.6000



Anticipating the lower pound, futures and option traders  at the CME piled in on the short side, and according to the weekly COT Report, on July 2nd, bears had amassed a short position totalling over 46K contracts. In retrospect the short position was wrong as is evident by the recent move up of the cable.

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The pound versus the USD has rallied almost 1400 pips since early July, it has been unusual to see bears holding on to their short positions, not flipping to the long side until the pound was trading above 1.5800

Part of the pound rally has been the result of economic data that was consistently better than expected.  In contrast six months earlier many saw the British economy on the verge of recession, which has for the time being been proven wrong.

What was behind this unexpected “boom”

Taxpayer subsidies that had been implemented for high loan-to-value mortgages resulted in an increase in new construction as well as increase in sales of existing properties.  The IMF has warned this is a risky policy and will result in a boom-bust situation.

Acknowledging there may be a real estate bubble, there is now a Financial Policy Committee within the BOE.  Their job is to deflate the bubble before it gets too big. 

The main issue with the British economy


The British government is simply too big, in fact way too large for the productive capacity of the economy. The state consumes 45% of GDP, but taxes raise less 36% of GDP — and no government in British history has ever managed to extract more than 38% of GDP in taxes.


A major reason why the government requires so much resources to function is costs associated with the EU membership. This membership gives Brussels the right to regulate and control much of the economy often without input or representation.  

One example of why it is costly to be an EU member; energy is expensive in England and most of Europe. To cope with high energy prices, Britain is beginning to drill for shale gas.  Some estimates claim the reserves on the island are enough for nearly fifty years of energy needs. The EU however would not approve of the UKs plans to drill its way to cheaper energy prices -  "The level of methane emissions tilts the balance for or against the development of shale: it is the central issue. We don’t want to copy and paste what happened in the US. We will do things differently in Europe," Jos Delbeke, the director-general of the European Commission's climate divisions said recently.

 
Mr Delbeke’s warnings come as Brussels draws up its framework law for shale by the end of the year, shaping rules that could make or break the industry in Europe. A tough code risks a cathartic showdown with Britain just as the country gears up for a referendum on EU membership. Any sense that Brussels was obstructing the UK’s economic revival could prove the last straw for many voters. "

What all this means is that the UK still has a tough road ahead and any strength in the pound will either be short lived or be caused by weakness in the US dollar. 



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