British Pound Slide Ominous Inflation Signal

When the British pound, like the U.S. dollar before it, started falling recently against other major currencies, a good news-bad news economic phenomenon kicked in.

Cheaper currency in the larger world consumer economies makes imports more costly, adding fuel to smoldering inflation which could soon disastrously ignite.

On the inflationary side, food and energy prices have increased in the U.K., accompanied by a corresponding uptick in labor costs. If consumer prices continue to rise, demand for higher wages will follow, adding momentum to the cycle.

On the positive side of the ledger, cheaper currency make exports to foreign buyers more affordable, lending support to a sagging economy. But that won’t help tamp down inflation.

The still-declining British pound began its slide after reaching a lofty high against the U.S. dollar in November, 2007, one not seen in 26 years. In the weeks that followed the pound nosedived 7 percent against the buck and 8 percent against the euro.

Analysts have attributed the fall of the pound to the same problems which have dogged the U.S. economy in recent months — a housing slump, credit crunch and a pullback in consumer spending.

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Christmas spending in the U.K. was substantially off, the slowest since 2004. Adjustable rates on existing mortgage are poised to spike higher in 2008. More rigorous lending standards will restrain consumer spending.

Similar circumstances have bashed the Canadian dollar, which has also fallen about 10 percent from its previous recent high against the U.S. dollar as the global economy demonstrates again how interconnected it all is.

Investors and currency traders expect Britain's central bank to follow the example of its U.S. counterpart and ease rates – another ominous sign of coming inflation — by some estimates as much as 1 percent, and perhaps more if necessary.

As of last week, however, the key U.K. rate remained at 5.5 percent, although a cut may come in February.

European equities responded to the U.K.'s unchanged rate, and a signal from the European Central Bank that it would consider hiking its rate, with a 1 percent sell-off in the Stoxx 600 index.

U.K. currency values also penetrated below a benchmark trading floor last week.

The pound traded at $1.963. Trades of the British pound below $2.00 are considered by some technical analysts and chart watchers to be strongly bearish, portending a further slide.

The gap between the pound and the euro has also widened, reflecting a still-robust European Union economy and a less healthy and potentially deteriorating situation in Britain.

A further drop in the pound's value would not surprise many analysts, investors and the inevitable speculators ever-vigilant for such opportunities.

Traders may now be shorting the pound as open short interest in the currency increases, awaiting the inevitable buy-backs at lower prices required to close the short trade.

Adding to the downward pressure on the value of U.K. currency is the news from Goldman Sachs, reported in The Wall Street Journal, that among its top 10 trades for 2008 is a bet against the pound.

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