Foreign Exchange Rate Forecast – The Pound initially fell against the Euro exchange rate


by Adam Solomon

Sterling / Euro and US Dollar

The Pound initially fell against the Euro exchange rate yesterday, while the UK currency also declined against the U.S Dollar, after the Confederation of British Industry lowered its UK growth forecast and a separate report showed that house prices fell by the most in seven months in April. The report from the Halifax showed that prices contracted 1.4% last month, compared with a 0.1% gain in March, a further indication that the economy is slowing under the government’s austerity measures.

The report from the CBI showed that UK gross domestic product will increase 1.7% this year, compared with a February estimate of 1.8%. The group also downgraded growth estimates for 2012 and the data released does not even take into account the full extent of the cuts. The economic outlook is likely to worsen over the coming months, giving the Bank of England further scope to keep rates on hold. The Pound took advantage of broad Euro weakness, recovering towards 1.14 in London, amid reports that Standard Poor’s downgraded Greece’s long-term sovereign credit rating.

The Greek downgrade had an impact on risk appetite and boosted the lower-yielding currencies like the U.S Dollar and Yen, as investors dumped so-called higher-yielding assets. SP’s decision to lower Greece’s debt rating was the fourth by the company since April last year, leaving the debt-ridden nation the second worst ranking country in terms of creditworthiness.

The renewed concern surrounding Euro-zone sovereign debt has weakened the Euro severely, but the Pound will remain susceptible to a weakening economic outlook and the economy hasn’t even absorbed the full extent of the fiscal cuts. Therefore, the data is likely to get worse over the coming months, which means rates will remain on hold longer and that will keep the Pound under pressure.

To that end, it is a little too soon to say that the Pound is bouncing back against the Euro and will trend higher over the coming weeks. The risks are still weighted to the downside because the European Central Bank are still expected to raise interest rates before the Bank of England. The BoE will release its quarterly inflation report tomorrow and given the tone of recent economic data, it’s likely that policy makers will downgrade growth and inflation forecasts.

The Bank of England face a difficult balancing act because inflation is still double the government’s 2% target and although consumer prices eased to 4% in March following five months of acceleration, the cost of living is still on the up and that will continue to feed into inflation over the coming months. Money markets are still factoring in a 25 basis point increase in the UK benchmark lending rate by year end but it’s unlikely unless the economy continues to grow.

The Pound gained further ground against the Euro during the Asian trading session overnight, rising to the highest level in more than a month, after a report from the British Retail Consortium showed that UK retail sales surged by the most in five years last month. The report showed that sales rose 5.2% in April and the reading follows a 3.5% drop the previous month.

A separate report from the Royal Institution of Chartered Surveyors showed that a gauge of UK house prices rose to its highest level in nine months in April. The number of real-estate agents and surveyors saying that prices fell exceeded those reporting gains by just 21 percentage points, the most since July 2010. It may be true that a fundamental lack of properties for sales may be propping up values because slow economic growth and tighter lending conditions has curbed demand for house-purchases.

Euro / US Dollar

The Euro exchange rate slumped to the lowest level in six weeks against the Yen and the weakest since April 19th versus the U.S Dollar, before the Greek debt auction today and speculation that the nation will default and have to restructure its debt over the coming weeks. The renewed tension surrounding sovereign debt in the peripheral economies in the Euro-zone has finally caught up with the Euro, particularly since the dovish tone of the ECB press conference last week.

The Euro sank back towards lows near 1.4250 against the Dollar, after Moody’s warned over the probability of further cuts in Greece’s credit rating over the next few weeks. Although the downgrades were anticipated, they reinforced the negative outlook surrounding the Euro. There is an increased fear that the economic crisis in Greece and a default on debt will result in Greek withdrawal from the Euro, which would cause major stresses within the Euro-zone banking sector.

The Euro recovered towards 1.4375 against the Dollar by the close of trading last night, as EU officials will be forced to find a workable solution ahead of the planned May 16th Euro-group meeting. Commodity prices initially attempted to recover from last week’s sharp decline and this also weighed on Dollar sentiment, as the U.S currency is still unable to derive any yield support.

Data Released Today

U.K 00:01 – BRC Retail Sales (April)

U.K 00:01 – RICS House Price Balance (April)

U.S 13:30 – Export Prices (April) – Import Prices

U.S 15:00 – Wholesale Inventories (March) – Sales

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