by Adam Solomon
Sterling / Euro and US Dollar
Following on from last week, the Pound continued to decline against the U.S Dollar exchange rate, dropping to a low of 1.6189 on Friday, while the UK currency also traded lower versus Euro, amid renewed concerns that the UK economy is drifting back towards negative growth in the second quarter. Recent economic data has shown that the key sectors of the economy are slowing and a report last week showed that UK manufacturing came in short of expectations in March.
Output at UK factories climbed just 0.2% from the previous month and overall industrial production rose 0.3%, despite initial estimates of a 0.8% increase. The report confirms that during the first quarter, production rose just 0.2%, clouding the economic outlook even further following declines in services, housing and consumer spending. Recent economic reports don’t even take into account the full extent of the government’s fiscal spending cuts and growth in the economy will probably deteriorate further over the coming months.
The Pound also came under further selling pressure against the Dollar as UK stocks slumped and commodity prices drifted lower. In the Bank of England’s quarterly inflation report, the governor Mervyn King said that while policy makers believe the recent “softness” in the UK economy will be temporary, there are clear “downside risks”, leading to a downgrade of growth projections this year.
The UK economy grew just 0.5% in the first quarter, lower than expected, and barely enough to erase the contraction from the fourth quarter of 2010. Although the industrial production data was weaker-than-expected, the index for manufacturing is now at its highest level since October 2008. There is every chance that the growth figures from the first quarter will be revised higher, but the risks to the economy are very much weighted to the downside.
The Pound declined against the Euro and the Dollar on Friday, dropping back under 1.14 versus the single currency, after the Institute for Fiscal Studies said that UK living standards will fall as inflation continues to accelerate and wage growth stagnates. The UK currency was weaker against all but two of the 16 most actively traded currencies, as earnings declined by 3.8% in real terms in the 11-months through February.
The Pound also weakened against the Euro, after the flash estimate of European gross domestic product in the first quarter showed that growth in France and Germany exceeded initial estimates. Although the peripheral economies in the Euro-zone are struggling with debt levels and Greece faces the uncertain prospect of restructuring, Germany, in particular, is showing signs that the economic recovery is gathering momentum, increasing the prospect of higher interest rates.
German GDP rose 1.5% in the first three months of the year, compared with 0.5% in the UK. We have been saying that the Pound’s recovery towards 1.15 against the Euro appeared tentitative at best and renewed weakness in the UK economy could prompt a move back towards 1.10 in the near future. In terms of economic data, the focus this week will be on the minutes from the Bank of England’s last policy meeting.
Policy makers voted to keep interest rates unchanged at 0.5% this month and the voting pattern is expected to mirror that of previous months, showing a three-way split. Elsewhere, the UK inflation data will be watched closely and a headline figure in excess of 4% would fall in line with the Bank of England’s projections that consumer prices are set to trend higher in the near-term.
A rise in inflation would also spur speculation that the MPC will raise interest rates before the fourth quarter and that should support the Pound. Other key UK report will include retail sales figures for April, which will probably show a positive result considering the number of Bank holidays in the last month and the Royal wedding. The unemployment rate is expected to edge higher, while house price data from Rightmove and DCLG also feature.
Euro / US Dollar
The Euro exchange rate remained under pressure against the Dollar last week, trading close to the lowest level in five weeks at 1.4125. Further weakness in commodity markets triggered fresh demand for the Dollar on a yield basis, while speculative positions were reduced. The structural vulnerabilities within the Euro-zone remained an important influence, amid further economic and political discussion surrounding the Greek debt situation.
The Euro did, however, receive a boost after Lucas Papademos, former ECB Vice President, said that restructuring the struggling nation’s debt is not necessary. The Euro subsequently bounced back towards 1.43 against the Dollar, but speculation that Greece will still need to restructure its debt may undermine the single currency in the weeks ahead.
The Euro also extended its climb against the Dollar on Friday, after European gross domestic product beat initial forecasts for the first quarter, showing strong growth particularly in Germany and France. This week, the focus in the Euro-zone will fall on various inflationary forecasts, which are expected to rank up the pressure on the ECB to raise interest rates in July.
After the strong growth reading from Friday, combined with faster inflation, policy makers may deem a rate increase necessary to maintain risks to price stability. Elsewhere, a Eurogroup meeting of finance ministers is due to be held on Monday and there will be speculation that additional support measures for Greece may be announced in the aftermath of the meeting.
In the U.S, the focus will be on the ailing housing market with existing home sales for April due for release, alongside the NAHB house builders’ survey. Elsewhere, the minutes from the FOMC April meeting will be released on Wednesday, while the Fed chairman Ben Bernanke is due to speak and may offer some fresh insight into monetary policy updates.