Tunnel vision

Sterling and UK economy tell different stories

Sterling's fortunes and those of the British economy have little to do with each other these days. Blame currency traders' near-obsessional focus on Britain's referendum on whether to stay in the European Union (EU).

Speculation that voters might be more inclined to remain has seen the pound claw back ground in the past few weeks. A trade-weighted measure of its value has risen four per cent since April 7, when it hit its lowest in more than two and a half years. This is exactly the opposite of what should have happened if economics mattered a jot right now.

British growth has slowed, with gross domestic product growing at a quarterly clip of 0.4 per cent in the first three months of this year compared with its 0.6 per cent rate of expansion in the last three of 2015, an official report said on April 27. And the Citi Economic Surprise Index shows UK data has switched from surpassing expectations to undershooting them by a fair margin over the course of this month - a peculiarly British problem, since comparable euro zone and US gauges have suffered no such marked downturn.

It's easy to see why traders may be ignoring such disappointments. The consequences of leaving the EU easily trump reports on how the economy performed in the recent past. Moreover, there's little chance of the data triggering monetary policy changes. Bank of England Governor Mark Carney has cemented expectations that rates will be kept at record lows for the foreseeable future by pointing out referendum-related economic risks.

These risks will keep enthusiasm for sterling in check, barring a huge surge in support for staying in the EU. True, investors have slightly scaled back expectations of how much the pound might gyrate in the next three to six months, reflected in so-called implied volatility. And their preference to sell rather than buy sterling over this period has diminished somewhat.

But two-month implied volatility, which now covers the June 23 referendum, has risen sharply, and so has the preference to sell sterling for euros on this time horizon. The reluctance to throw caution to the wind is wise. Voters are even harder to read than economic runes.