Foreign Currency Exchange Rate Forecast – The Pound declined against all of the 16 most actively traded currencies

Currency

by Adam Solomon

Sterling / Euro and US Dollar

The Pound declined against all of the 16 most actively traded currencies yesterday, after Moody’s Investors Service warned that 14 British banks will be under review and may lower the credit ratings of some of the nation’s biggest institutions. The UK currency slumped to a low under 1.61 versus the Dollar and also traded back towards 1.1450 against the Euro, after a government report showed that the UK budget deficit unexpectedly widened in April.

The Pound suffered the most against the New Zealand Dollar, falling to a near record low, after net borrowing was recorded at £10 billion, compared with £7.2 billion a year earlier. The government’s austerity measures are designed to eliminate the majority of the nation’s deficit by 2015 but the report will not inspire confidence and despite the severe cuts, officials will find it difficult to curb borrowing.

Britain has posted its largest budget shortfall for any April since monthly records began in 1993, bringing into doubt whether government can meet its deficit-reduction target this year. Economic growth stagnated in the six months through March and the government will step up its mandate to continue with the cuts this year, despite the risks it poses to the economy.

The shortfall in the budget reached a record £156.5 billion, which equates to 11.1% of UK gross domestic product, in the months that followed the worst recession in a generation. The deficit is forecast to narrow to £122 billion in the current fiscal year, representing 7.9% of GDP. The opposition party will argue that the pace of the spending cuts will hamper consumer confidence and derail the recovery.

The report yesterday will also serve as a reminder that officials have an uphill struggle to sort out the state of public finances. The Moody’s announcement also weighed heavily on the Pound and the UK currency depreciated 0.4% versus the Euro before recovering later in the day on renewed concern over sovereign debt and the threat of contagion in the Euro-zone.

The vulnerability of the UK economic recovery has forced Bank of England policy makers to ignore the threat of inflation and maintain interest rates at the lowest level on record. The MPC voted 6-3 this month in favour of keeping rates on hold, as some members expressed concern that an immediate increase could hurt consumer confidence. Even the most hawkish members of the panel that voted for an increase altered their stance with a slightly bearish tone to the statement.

Money markets are now pricing in a 25 basis point increase in the benchmark lending rate in February, according to the sterling overnight interbank average. The Pound bounced back towards 1.15 against the Euro overnight and made gains versus 11 out of the 16 most actively traded currencies, before a report this morning that is expected to show that the UK economy rebounded in the first quarter.

The revised figures for first quarter growth may show that the economy expanded by more than the 0.5% initial estimate and a more robust figure would tend to support Sterling and the idea that the economy is gaining momentum. The latest CBI retail sales survey was also stronger-than-expected and policy maker Martin Weale said that a rise in UK interest rates was “advisable.”

Euro / US Dollar

The Euro bounced back for the first time in three days against the U.S Dollar, as global stock markets rallied and German business confidence remained close to a record high in May. The report will fuel bets that the European Central Bank will raise interest rates again over the Summer, extending the yield advantage by a further 25 basis points.

The Euro gained towards 1.4150 against the U.S Dollar before losing momentum, amid concerns over sovereign debt and the public debate over appropriate policy actions. The ECB remains steadfast in its opposition to any form of restructuring to Greece’s debt, while markets remain convinced that some form of partial default is inevitable.

In the U.S, the new home sales data was stronger-than-expected at 323,000 for April, from a revised 301,000 previously, while there was a decline in the Richmond Fed manufacturing index. Neither report had a significant impact on the market and the brief improvement in risk appetite put the Dollar under pressure. It didn’t last long, however, as Asian equity markets dropped to a the lowest level in two months, while commodity prices fell, renewing the demand for the Dollar and the Yen as a safe haven.

Today’s Data

U.K 09:30 – Revised GDP (Q1)

U.S 13:30 – Durable Goods (April)

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