by Adam Solomon
Sterling / Euro and US Dollar
Following on from last week, the Pound received a short-term boost on Thursday, before dropping back towards 1.1220 versus the Euro exchange rate, after a report from the Chartered Institute of Purchasing and Supply showed that UK construction rose above initial forecasts last month. The UK currency was relatively unchanged against the U.S Dollar, after moving under 1.64 on Wednesday.
The marginal improvement in the construction sector will do little to dispel fears that the UK economy is losing momentum. The Pound also came under renewed selling pressure, after Bank of England policy maker Paul Fisher said that he would consider renewing the quantitative easing policy if the economic recovery lost momentum.
The UK economy grew just 0.5% in the first quarter, just enough to erase the previous quarter’s contraction, while the headline inflation rate accelerated to a two-year high. Fisher said yesterday that “I want to make sure we get over this soft patch before we begin the inevitable” of raising interest rates from the record low. He added, “zero consumption puts a very heavy burden on the export side to deliver and overall growth and flat consumption is something which is very vulnerable to downside shock.”
Any speculation over an extension to the asset-purchase plan, which was capped at £200 billion, would tend to undermine confidence in the Pound and UK assets as a whole. The Euro gained ground on speculation that the European Central Bank will raise interest rates over the next couple of months, after the ECB chairman Trichet warned that risks to price stability need to be contained. – a sure indication that the governing council may be leaning towards a July increase.
The Pound was down for a third straight day against the Euro, reaching the lowest level since May 6th, and the extent of the decline in Sterling over the past week suggests a move back towards 1.10 is just a matter of time. The ECB are more than likely to raise interest rates again before the Bank of England, extending the yield advantage by another 25 basis points.
The negative sentiment engulfing the Pound has increased significantly, with marginal weakness in economic data enough to trigger a move lower. The UK currency lost over 1% in value against the Euro on Friday and posted further declines against a basket of currencies, including the Swiss Franc, trading at the lowest level 16-years.
The Pound has declined 3% against the Euro this year, as the Bank of England’s credibility was cast into doubt following the failure to control rising inflation. Deteriorating economic growth, amid the most aggressive public spending cuts in a generation, reinforced concerns that the economy is faltering towards another contraction.
In contrast, the ECB raised interest rates in April and are displaying the intent to increase again over the coming months, despite concerns over sovereign debt that has led to speculation Greece would default on its deficit-reduction plan and require a restructuring of its debt. Portugal and Ireland also requested financial aid from the EU and IMF but strong growth in France and Germany has driven the Euro-zone economy in the first quarter of 2011.
The Pound was down against the Euro and continued to struggle versus the majority of the major currencies by the close of trading on Friday, after an index of UK service industries dropped by more than expected last month. The CIPS services PMI fell to 53.8 in May, from 54.3 in April, and the report is just the latest indication that the Bank of England will keep interest rates on hold at 0.5%.
The Pound recorded a weekly loss against all of the major currencies and Barclays Capital scaled back its forecast for a UK rate increase, after the manufacturing figures fell to the lowest level in almost two years. Data this week also showed that mortgage approvals dropped to the fewest amount in four months, prompting renewed speculation that growth is slowing.
The Pound bounced back from 1.6279 against the U.S Dollar exchange rate, while the greenback also declined against the Euro and Yen, after the monthly U.S employment report showed that employers added fewest amount of jobs in eight months. The unemployment rate also increased to 9.1%, raising concern about the U.S economy.
The focus this week, in terms of economic data, will fall on the BRC retail sales numbers for May, which is expected to show a sharp deterioration from the previous month. Separate reports on the UK trade deficit and industrial production for April should provide an insight into gross domestic product in the second quarter.
Euro / US Dollar
The Euro recorded its longest stretch of weekly gains against the U.S Dollar since March, as concerns surrounding Greece receded and further question marks arose over the sustainability of the U.S economic recovery. A report on Friday showed that U.S employers added fewer jobs than expected in May, while the jobless rate rose, prompting speculation that the FOMC will leave interest rates on hold for the remainder of the year.
The single currency also benefited from speculation that a report this week will show that European producer-price inflation accelerated and that may lead to a hawkish statement from the ECB on 9th June. The recent revival in risk appetite has also reduced the appeal of the Dollar as a haven and increased investors’ appetite for risk.
The focus this week will inevitably fall on the ECB rate announcement on Thursday and markets are already pricing in a 25 basis point increase in July. Therefore, the post meeting press conference will take on added significance and the language used will be heavily scrutinized for a definitive sign that policy makers are ready to act. Aside from the ECB meeting, the main focus in terms of economic data is likely to be Wednesday’s release of the details of gross domestic product in the first quarter.
EU 09:30 – Sentix Investor Sentiment (June)
EU 10:00 – Producer Price Index (April)