by Adam Solomon
Sterling / Euro and US Dollar
The Pound declined against the Euro exchange rate for the sixth consecutive day, falling towards a low of 1.1150, while the UK currency also weakened against the Dollar, along with a basket of currencies. Moody’s Investors Service reported that the UK’s Aaa credit rating may be at risk should the government fail to meet the deficit-reduction targets.
The UK economy is slowing in the second quarter and there are increasing concerns that we may see a contraction in growth in the three months to June. Consumer spending has slumped in the wake of the government’s aggressive public spending cuts, while other key areas of the economy in manufacturing and housing continue to struggle. The report from Moody’s yesterday reinforced a lack of confidence in the economy, especially as there has already been a level of criticism aimed at the government for tightening policy too quickly.
Weak growth and accelerating inflation has prompted speculation that the Bank of England will keep interest rates at a record low for the remainder of the year. The Pound is declining against the Euro on a daily basis amid speculation that Europe will announce a rate increase in July at the monthly press conference today. Therefore, Euro buyers may be well placed to take advantage of the current rate before further losses are likely this week, while the Pound also looks poised to fall further versus a basket of currencies.
The Bank of England face a difficult balancing act and have sacrificed a level of credibility in recent months by allowing inflation to surge to the fastest pace in two-years. The MPC are concerned that raising interest rates too quickly would potentially risk the economic recovery and as such policy makers have adopted an extremely cautious stance in recent months.
The overall policy mix will continue to combine a tight fiscal policy with low interest rates and we are not expecting a change in the benchmark lending rate during the BoE announcement at midday. The Pound has bounced back above 1.64 against the Dollar during the U.S session last night, as the Euro was subjected to profit taking.
The Pound will be susceptible to speculation that ratings agencies are considering downgrading the UK credit rating if the economy begins to slow and the government fails to meet its deficit-reduction target. The UK currency has weakened 3.8% against the Euro this year, amid signs that the government’s austerity drive is dampening growth and will force the Bank of England to keep rates on hold.
The Chancellor of the Exchequer George Osborne said earlier this week that he rejected calls to scale back the deficit-reduction plan, as consumer confidence dropped. The IMF have endorsed the government’s strategy, while warning that the UK faces risks to growth and employment. Standard Poor’s affirmed the UK’s AAA ranking in October, after Osborne presented his plans for fiscal cuts.
The Pound remained largely unchanged against the Euro exchange rate overnight but the UK currency may struggle to remain above 1.12 ahead of the rate announcements this lunchtime. Sterling has fallen against the Euro on all but one day this month, as investors added to bets that the ECB will signal the intent to raise interest rates in July.
The Bank of England governor Mervyn King may have derived more support to keep interest rates at a record low this month, after staunch hawk Andrew Sentance left the panel on May 31st having been unsuccessful in his push to raise interest rates by an immediate 50 basis points. MPC member Paul Fisher said last week he would prefer to make sure the economy is over its “soft patch” before a rate increase.
Euro / US Dollar
The Euro exchange rate climbed towards the highest level in a month against the U.S Dollar yesterday, as speculation over an ECB rate increase for July reaches fever pitch. A lot of focus will be on the ECB press conference this afternoon and the language used by the chairman Jean-Claude Trichet will come under added scrutiny for signs that the governing council are preparing to act next month.
The Euro was, however, unable to break above 1.47 level against the Dollar and was subjected to renewed selling pressure. Media reports that the IMF report on Greece would indicate that the next loan tranche payment could not take place without corrective action on failure to meet existing revenue targets weighed on the single currency.
The report triggered fresh concerns over the Greek default risk and that undermined confidence in the Euro. The single currency is likely to receive a significant boost if Trichet indicates a rate increase is coming in July. However, should the ECB head fail to deliver the sort of hawkish rhetoric that the market is anticipating then the Euro would come under heavy selling pressure.
U.K 09:30 – Trade Balance (April) – Non EU Trade
U.K 12:00 – BoE Interest Rate Announcement
EU 12:45 – ECB Interest Rate Announcement
ECB 13:30 – ECB Press Conference Forecasts
U.S 13:30 – Initial Jobless Claims (w/e 4th June)
U.S 15:00 – Wholesale Inventories (April)