Exchange Rate Forecast – The Pound plunged to the lowest level against the Euro


by Adam Solomon

Sterling / Euro and US Dollar

The Pound plunged to the lowest level against the Euro exchange rate since March 2010 yesterday, trading down to a low of 1.1079, following data from the Nationwide Building Society that UK house prices dropped for the first time in three months, while construction growth also slowed. The recent negative tone of UK economic data has increased concerns that the UK economy could slip into negative growth again during the second quarter, as the government’s austerity measures take hold.

Gross domestic product rose just 0.5% in the first quarter, erasing the fourth quarter contraction, but the aneamic pace of growth will make it difficult for the Bank of England to focus on inflation and raise interest rates in the near-term. The decline in the Pound has been severe, with the UK currency trading at the lowest level since at least 1975 versus a basket of currencies, including the Australian Dollar.

It seems increasingly likely that the Pound will trade under 1.10 against the Euro over the coming days, amid speculation that Europe will raise interest rates again over the Summer, extending the yield advantage by a further 25 basis points. The worsening economic outlook will ease pressure on the MPC to consider raising interest rates and policy makers are expected to leave rates on hold at 0.5% this lunchtime.

The construction PMI disappointed investors yesterday, as the gauge of building activity based on a survey purchasing managers fell to 53.3 in April, from 56.4 the previous month. The tone of the report mirrors the disappointing manufacturing and housing figures earlier this week and the focus this morning will fall on the latest service sector growth.

The report is expected to follow a similar pattern with growth in services industries expected to slide back towards a reading of 55.7, from 57.1 in March. A result worse-than-expected would tend to undermine the Pound further and that may be the catalyst for a move towards the pivotal 1.10 level against the Euro.

Elsewhere yesterday, UK mortgage approvals were virtually unchanged in March, as stagnant wage growth filtered through the housing market. Lenders granted 47,557 home loans in March, while net mortgage lending rose just £400 million, half the average over the previous six months. The UK currency also declined against the weak U.S Dollar, two of three worst performing currencies this year.

To compound matters, the National Institute of Economic and Social Research downgraded its GDP forecast for the UK and stated that the shortfall would prevent the government from meeting its borrowing projections. In addition, risk conditions will be watched closely and the Pound will be vulnerable when there is a deterioration in market confidence, particularly against the Dollar and the Yen.

Euro / US Dollar

The Euro exchange rate reached its strongest level against the U.S Dollar in 17 months yesterday, as we build up to the ECB interest rate announcement and accompanying press conference today. There is widespread speculation that the chairman Jean-Claude Trichet will signal that further interest rate increases are likely over the coming months.

Trichet will use a specific rhetoric to signal a further rate increase in the Euro-zone, saying that strong vigilance is required to ensure that risks to price stability are contained. That would spark suggestions that the ECB are preparing to hike rates again in June and the Euro would rally significantly against its major trading partners. Of course the lack of commitment in the statement could potentially disappoint investors and undermine the Euro.

In the U.S, the headline ADP employment report was marginally worse-than-expected with a 179,000 private sector job increase for April. The figure dampened expectations surrounding Friday’s non-farm payrolls release, although the impact yesterday was minimal. There was, however, a much bigger reaction to the ISM non-manufacturing index, which recorded a sharp decline for April, highlighting the fragility of the U.S economy.

Data Released

U.K 09:28 – CIPS Services PMI (April)

GER 11:00 – Industrial Orders (March)

U.K 12:00 – BoE Interest Rate Announcement

EU 12:45 – ECB Interest Rate Announcement

EU 13:30 – ECB Press Conference

U.S 13:30 – Initial Jobless Claims (w/e 30th April)

U.S 13:30 – Productivity (Q1 Prelim)

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