Pound Bears Bet More Than When George Soros Beat BOE (Update1)

By Bo Nielsen and Lukanyo Mnyanda
March 15 (Bloomberg) -- Futures traders are more bearish than ever on sterling amid concern that the currency’s worst annual start in 13 years will continue as the U.K.’s budget deficit approaches the Greek shortfall that roiled the euro.
Wagers on the pound weakening against the dollar outnumber futures that profit on a rise by eight times more than when George Soros made $1 billion betting against the currency in 1992, the year Prime Minister John Major’s Conservative government was forced to withdraw from the European Exchange Rate Mechanism. Sterling fell 19 percent that year.
The pound has lost 6.2 percent in 2010 on speculation a budget gap will skewer the currency: Either record borrowing will push debt costs higher and force policy makers to print more money to buy bonds, or lawmakers will cut spending too fast and trigger a new recession. Prime Minister Gordon Brown’s government estimates the deficit will hit 12.6 percent of gross domestic product, almost as high as the 12.7 percent in Greece that drove European leaders to consider a bailout.
"The risk of a U.K. double dip is substantial," said Hans-Guenter Redeker, London-based head of foreign-exchange strategy at BNP Paribas SA, which predicts an additional 13.6 percent drop to $1.31 by the end of 2010. "Sterling is increasingly trading like an emerging-market currency with rising bond yields no longer working in favor of the currency."
Ten-year gilt rates have climbed more than a percentage point in the past year, the fastest increase since mid-2004.

Lower Forecasts

BNP, whose Sept. 8 forecast for this quarter is closest to the mark in a Bloomberg survey, is now the most pessimistic of 36 strategists. After reducing their median prediction 2 percent in January, strategists cut it 3 percent this month, the quickest drop since September. Twenty-two strategists see the pound ending the year below 2009’s $1.6170 close.
Brown said March 10 the economic recovery is "still in its early stages and remains very fragile." His Labour Party is locked in an election battle that may lead to the first Parliament stalemate in 36 years and reduce the chances of enacting his five-year plan to cut the shortfall to 4.4 percent of GDP, which Fitch Ratings already has called "too slow."
Sterling was at $1.5167 today, up 0.7 percent for the past week. The currency slid 0.2 percent against the euro to 90.63 pence, down 2.1 percent this year. The pound is the only one of 16 most-traded currencies tracked by Bloomberg to weaken over the past six months against the euro.

Bullish Strategists

Strategists remain bullish on the pound even after cutting their forecasts. The median prediction of 35 analysts in Bloomberg’s survey calls for a 4.9 percent gain to $1.59 per pound by Dec. 31, down from a consensus of $1.67 on Jan. 28.
The pound’s drop may already reflect the deficit. At 4.098 percent, 10-year gilt yields are up 115 basis points in the past
12 months and were 103 basis points higher than German bund rates on Feb. 23, the biggest gap in more than four years.
Greek yields have risen as much as 139 basis points this year and closed at 6.25 percent last week. Gilt rates have risen no more than 22 basis points since Jan. 1, peaking at 4.23 percent on Feb. 22. British government debt was 55.8 percent of the economy in 2009, less than half of Greece’s 113.4 percent, according to Goldman Sachs Group Inc.
The U.K. isn’t facing a financial crisis in the "foreseeable future," You-Na Park, an analyst at Commerzbank AG in Frankfurt, wrote in a March 10 note to clients.

Helpful Drop

Erik F. Nielsen, Goldman Sachs’ chief European economist, said the pound’s 8 percent drop versus the dollar and 1.9 percent decline against the euro in six months will propel a recovery in the U.K. economy and help the currency reach $1.73 by August.
"People are very bearish on the U.K., probably more than they should be," Nielsen said in a March 8 interview in Sydney.
British yields, the highest in the Group of 10, have risen as record debt sales of 225.1 billion pounds ($341 billion) in the fiscal year ending this month prompted investors to sell gilts. Foreigners sold a net 1.49 billion pounds of U.K. bonds in January, the most in nine months, central bank data show.
Higher yields usually shore up currencies by encouraging investments with cash from economies with lower borrowing costs.
"When yields go up in a country watched by the rating agencies, it doesn’t mean that people are more enticed to buy the currency," said Stephen Jen, a London-based managing director at BlueGold Capital Management LLP. "It means there’s a risk premium being priced in. The U.K. has huge problems that are not being addressed while Greece’s problems have been addressed somewhat."

‘Completely Over’

Investors bought 5 billion euros ($6.9 billion) of Greece’s debt this month as the government announced spending cuts and tax increases totaling 4.8 billion euros. The crisis is "completely over" and won’t hit other euro countries, former European Commission President Romano Prodi said in a interview on March 10.
Reining in the U.K. deficit may not be enough to save the pound, Mansoor Mohi-uddin, Singapore-based strategist at UBS AG, the world’s second largest currency trader, wrote in a Feb. 24 research note.
"If the next government was to prematurely curb the fiscal deficit after the elections, without the economy reaching a surer footing, the consequences for sterling, financial markets and public confidence would be grave," Mohi-uddin said. In a worst-case scenario, the currency would fall to parity with the euro and to $1.05, the lowest level since 1985, he said.

More In Sync

Measured against a basket of Group of 10 currencies proportioned by how correlated they are with each other, the pound has fallen 38 percent since 1974, the worst performer after the New Zealand dollar and Swedish krona, Bloomberg Correlation-Weighted Currency Indexes show. The pound and the euro are more in sync with each of the G-10’s currencies than the others, signaling they have the greatest effect on exchange rates.
Hedge funds and large speculators had 67,549 more bets the pound would decline against the dollar than contracts that profit from a rise as of March 2, data from the Commodity Futures Trading Commission in Washington show. Futures traders haven’t been that bearish since at least January 1986, as far back as CFTC data go.
The so-called net-short position has averaged 60,548 in the five weeks to March 9, compared with about 7,200 in October 1992, when Soros was profiting from the pound’s plunge.

Soros Vs Major

Two years earlier, the U.K. had joined the European Exchange Rate Mechanism, a euro precursor that required members to keep currencies within trading bands. Soros, who now oversees about $25 billion at Soros Fund Management LLC in New York, wagered that the U.K.’s growing deficit and falling dollar would make it impossible for the British to defend the pound with interest-rate increases and sterling purchases.
On Sept. 16, 1992, Prime Minister Major capitulated, allowing the pound to slide almost 24 percent that September, October and November, sterling’s worst three months since at least 1971. Black Wednesday, as the day became known, earned Soros’s Quantum Fund $1 billion on what he later told the Times of London was a bet "worth almost $10 billion."
Prices for protecting Greek and British debt shows today’s shift in sentiment. Five-year credit-default swaps for Greece cost 2.92 percentage points last week, more than four times what U.K. debt insurance sold for, down from five times on Jan. 28.
U.K. bonds lost 2.8 percent in the year through March 12, even as Bank of England bought 200 billion pounds worth, equivalent to 89 percent of planned sales, indexes compiled by Bank of America Corp.’s Merrill Lynch unit show. Treasuries returned 0.6 percent in the same period.
The pound also is being weighed down by speculation the next government will be too weak to cut the deficit.

Poll Results

Polls show the campaign is tightening in advance of elections that must be held by June. A YouGov Plc survey in The Sun newspaper on March 10 showed the Conservatives with 36 percent support compared with 32 percent for Labour, the latest in a series of poll results giving neither side enough support for a parliamentary majority. The last U.K. election to end that way, in 1974, was followed by a 28 percent slide in the pound over the next two years.
Sterling’s weakness has done little to boost growth by making exports cheaper. U.K. factory production unexpectedly fell in January for the first time since August, a government report on March 9 showed. The trade deficit in the same period swelled to the widest in 17 months. Exports slumped even after sterling declined 30 percent on a trade-weighted basis since June 2007.

Weak Demand

"I’ve been waiting 40 years for an export-led U.K.
recovery, and I haven’t seen one yet," said Robin Marshall, director of fixed income in London at Smith & Williamson Investment Management, which oversees about $20 billion. "A weaker exchange rate isn’t going to be sufficient to drive a recovery when external demand remains weak."
Policy makers are prepared to do "whatever seems appropriate" to prevent an economic relapse, Bank of England Governor Mervyn King told lawmakers Feb. 23. Adam Posen, a monetary policy committee member, said a day later the BOE may expand a program to buy government bonds with newly printed money if economic growth is weaker than expected.
Richard Howard, a managing director at Dallas-based money manager Hayman Advisors LP, said a drop of 14 percent to $1.30 per pound is possible.
"The U.K. is in a pretty precarious position," said Howard, whose hedge firm earned $500 million betting on the U.S.
subprime mortgage-market collapse. "The substantial currency devaluation hasn’t improved their trade position very much, and quantitative easing hasn’t kept the 10-year yield from creeping up. That is a dangerous sign."