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Forex Flash: Could GBP return to risk-traded currency? – UBS

Right until the recent crisis, it appears that investors were on a structural level over-optimistic ('irrational exuberance' springs to mind). Central bank puts (pre-crisis) and imbalances could not defy gravity and everything came to head in 2008. Ever since, the market has probably learned to keep expectations to the bare minimum, and count on the economy to consistently outperform. This way, the process reinforces itself and a positive cycle develops as activity levels rise higher than expectations. According to Research Analyst Gareth Berry at UBS, “For some reason, the process is working in the opposite way in the UK. Data consistently disappoints, which leads to weaker expectations - and crucially - even weaker activity. The asymmetry suggests some element of 'loss aversion' in play: economic agents are unwilling to invest because expectations are weak, rather than take the risk to capture potentially outsized gains (via first-mover advantage).”

Such behavior on a collective level only reinforces itself as data disappoints further because the 'active' agents are scarcer than anticipated. This is why the Bank of England is using schemes like the FLS to suppress potential losses and loss aversion, yet the results have been meager for now. Perhaps patience is still needed: like currency valuations, only when psychology reaches extremes, can the reversion process begin. And when it does, the recovery will be far stronger than expected.

This will mark the true turnaround for the UK economy and sterling may even start to trade as a risk currency, as was the case in mid-2000s. As Budget Day approaches, in addition to changing the terms of policy debate, perhaps it's now time for the Treasury and BoE to change the tone as well.

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