by Adam Solomon
Sterling / Euro and US Dollar
The Pound fell against the Euro exchange rate yesterday, while the UK currency also lost ground versus the majority of the 16 most actively traded currencies, ahead of the Bank of England’s quarterly inflation report this morning. The central bank is expected to lower growth and inflation projections over the coming months, as the economy struggles to gain traction, amid the most aggressive government cuts in a generation.
The Pound declined even after UK economic data surprised to the upside and showed an unexpected increase in retail sales and house prices last month. The report from the British Retail Consortium showed that sales rose 5.2% in April from a year earlier, as public holidays and the warmest April on record encouraged spending.
The reading follows a 3.5% annual drop in March and spending may falter once more as consumers are squeezed by faster inflation and the government’s fiscal tightening. The economic outlook is still clouded with uncertainty and yesterday’s data won’t change the stance of the Bank of England, who are likely to keep rates unchanged until the fourth quarter.
The negative tone of recent economic reports doesn’t dispel the fact that the economy is likely to get worse, as the full extent of the cuts are felt. The Pound made gains against the U.S Dollar last night, after UK stocks rallied for the first time in three days following the rebound in commodity prices during the Asian trading session.
Although the focus has switched to the problems with Greece and a possible restructuring of its sovereign debt, the Pound is still unlikely to extend its recent upward surge with the risks still weighted to the downside. The underlying fact is that the European Central Bank are far more likely to increase interest rates again over the Summer, extending the yield advantage of the Euro by another 25 basis points.
The Bank of England’s quarterly inflation report is likely to include a significant downgrade to growth expectations and the Pound may come under renewed selling pressure this morning. The governor of the BoE Mervyn King has said that a rise in borrowing costs at this stage could create more problems in terms of the economic recovery.
King told a committee of the European Parliament on May 2nd that “the economic consequences of high-level indebtedness now would become more severe if rates were to rise.” The Pound has approached the lowest level in over three weeks against the Dollar this morning, on speculation that the quarterly inflation report will signal that interest rates will remain at a record low over the coming months.
Euro / US Dollar
The Euro exchange rate traded close to the lowest level in three weeks against the US Dollar yesterday, finding support below 1.43, as risk conditions remained slightly firmer as global stocks bounced back following the slump from last week. The situation with Greece remains an important factor, especially amid speculation that the struggling nation will need to restructure its debt.
There were also reports from within the German government yesterday that Greece may not qualify for the next loan tranche under the existing agreement and there will be further speculation that Germany will also demand tougher conditions imposed on Greece to provide additional fiscal support. Uncertainty over sovereign debt will remain a key factor, especially given the potential contagion risks to other high-deficit nations.
There was a distinct lack of U.S economic data released yesterday and markets continued to focus on the monetary policy and the end of the quantitative easing policy in June. The Dollar will rise and fall on risk sentiment and a rebound in commodity prices early this week has rekindled investors’ appetite for riskier assets.
Data Released Today
U.K 09:30 – Trade Balance (March) – Non EU Trade
U.K 09:30 – DCLG House Prices (March)
U.K 09:30 – BoE Quarterly Inflation Report
U.S 13:30 – International Trade Balance (March)
U.S 19:00 – Federal Budget (April)