Foreign Currency Exchange Rate Forecast – The Pound took advantage of broad Euro weakness

Currency

by Adam Solomon

Sterling / Euro and US Dollar

Following on from last week, the Pound received a timely boost towards the end of the week, rising up towards 1.62 against the U.S Dollar and bouncing back from 1.1350 versus the Euro, after a report from the Office of National Statistics showed that retail sales rose by more-than-expected in April. Sales increased 1.1% from the previous month, despite expectations of a 0.8% increase, following the two bank holidays and improvement in consumer spending through the Royal Wedding.

The Nationwide Building Society reported earlier in the day on Thursday that consumer confidence had plummeted in the past month and the figures from the ONS may prove to be skewed to the upside.
UK unemployment claims rose in April, while inflation surged to the highest level in two years, squeezing household spending and dampening sentiment.

The increase in retail sales was the biggest for the month of April since 2002 and from a year earlier sales increased 2.8%. The Bank of England have kept interest rates at a record low this month, with policy makers concerned that an increase in borrowing costs would potentially weaken consumer spending and curtail the pace of the recovery.

The Pound declined against the majority of the 16 most actively traded currencies through the course of the day, as investors treated the unexpected increase in retail sales as a one-off. If consumer spending resumes the negative trend in May then interest rates are likely to remain on hold until the end of the year. According to the sterling overnight interbank average, money markets are now anticipating a rate increase from the Bank of England as late as January.

The Pound took advantage of broad Euro exchange rate weakness over the weekend, while the single currency also plunged to the lowest level in a week versus the U.S Dollar, after Spain’s Socialist party suffered its worst electoral defeat in more than 30-years and Standard Poor’s on May 20th said that it may lower Italy’s credit rating.

The Spanish elections and demonstrations in the centre of Madrid have reinforced concerns surrounding European sovereign debt and the Euro is vulnerable to reports that the peripheral economies continue to struggle. Despite accelerating growth and inflation in Germany and France, which will prompt the ECB to raise interest rates again over the Summer, there is still a high degree of uncertainty surrounding the higher-deficit nations.

The Pound surged above 1.15 against the Euro exchange rate during the Asian trading session last night and a move beyond 1.1550 could turn the trend towards the upside. However, the Pound will remain vulnerable to question marks about the sustainability of UK economic growth, amid speculation that the Bank of England will leave interest rates at a record low for the remainder of the year.

The UK currency also made gains against the Euro, as Greece’s credit rating was slashed three levels by Fitch Ratings, reducing demand for the single currency. In addition, a report this week is expected to show that the UK budget deficit is expected to narrow in April with net borrowing at £6.5 billion, from 18.6 billion in March.

The Bank of England’s Chief Economist Spencer Dale said over the weekend that the MPC should raise interest rates to tame inflation even if it will jeopardise the UK economic recovery. Dale said that “I’m not at all confident that the recovery has taken hold and will definitely power away. However, I’m even more worried about what’s going on in terms of inflation.”

There is a sparse supply of economic reports released in the UK this week and for that reason the Pound may take advantage of wider sovereign debt issues surrounding the Euro. The details of gross domestic product in the first quarter is likely to be the main focus of attention and a revision higher would certainly boost the Pound.

Euro / US Dollar

The Euro edged higher against the US Dollar exchange rate through the course of the week, hitting a high of 1.4350 on Friday, but the single currency was subjected to heavy selling pressure over the weekend. Further ratings downgrade to Greece and reports that Norway had suspended a scheduled loan payment as conditions had not been met undermined confidence in the Euro.

The International Monetary Fund and EU inspectors also called off their inspection of Greece stating that further progress on agreed reforms was necessary before it could continue. Italy’s credit rating was also downgraded to negative by SP, which increased concerns about the potential of contagion to other higher-deficit regions.

Subsequently, the U.S Dollar gained support from a global deterioration in risk appetite and the Euro slumped to lows close to 1.4150. The focus this week in terms of U.S economic data will be on the second estimate to U.S gross domestic product in the first quarter. Other data of note will be April’s personal income and consumption report, while separate data on housing and consumer spending will also feature.

Today’s Data

EU 08:58 – Flash Markit Manufacturing PMI (May) – Services – Composite PMI

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