by Adam Solomon
Sterling / Euro and US Dollar
The Pound initially rallied against the majors yesterday in the foreign exchange rate markets, rising 0.4% versus the Euro and surging higher versus a weak Dollar, after the Office of National Statistics reported that UK Gross Domestic Product increased 0.5% in the first quarter. The result of the data was in line with expectations but the anaemic pace of the recovery will make it difficult for the Bank of England to raise interest rates before the Autumn and that may weaken the Pound, which is already the third worst performing currency this year.
If GDP increased beyond 0.7% and inflation accelerated in April, the BoE would have the impetus to raise interest rates in May or June. However, the data yesterday has provided some relief for Sterling in the very near-term but it is unlikely to last, amid speculation that Europe will raise interest rates again over the Summer, extending the yield advantage by another 25 basis points.
Euro exchange rate buyers may wish to take advantage of this minor improvement, because investors still anticipate a move towards 1.10 in the short-term. The UK currency has bounced back above 1.65 versus the U.S Dollar and the inherent weakness of the ‘greenback’ makes it more likely that the upward move can be sustained through 1.66.
Effectively, the UK economy rebounded in the first quarter by just enough to erase the contraction from the final three months of the year, amid the strongest surge in services sector growth in four years. Bank of England officials are split on whether the recovery is strong enough to withstand the biggest public spending cuts in the post war era, allowing them to remove stimulus measures and adopt a tightening bias.
The crumb of comfort from the GDP data yesterday is that at least the UK economy is growing again because a further contraction in the fourth quarter would have equated to a technical recession. It seems increasingly likely that the Bank of England will wait until November before considering raising interest rates when the economy should be on a much stronger footing.
Britain is the first of the G-7 nations to report on first quarter economic growth and the recovery in services industries is the main driver of the expansion. UK manufacturing has also been solid, increasing 1.1% in the first quarter, but construction contracted 4.7%, the most in two years, making the recovery fragile and uneven.
The Pound’s 20% decline in value since the start of 2007 has boosted manufacturers by making British exports cheaper than rivals abroad, but they face pressure to raise prices because of higher commodity prices. The Confederation of British Industry reported earlier this week that the average selling prices for factories reached the highest level since January 1990.
The Pound took advantage of broad Dollar weakness last night, rising to the highest level since December 2009 at 1.6750, despite reports that UK consumer confidence slumped to its weakest level since February 2009. An index of consumer sentiment fell to minus 31 in April, as the government’s spending cuts began.
Despite widespread speculation that the Bank of England will keep interest rates on hold, the Pound’s upward momentum against the Dollar continued, after the U.S Federal Reserve kept their benchmark rate on hold last night. The Chairman Ben Bernanke signaled that he was unsure when monetary stimulus will unwind, indicating that further quantitative easing is possible.
Euro / US Dollar
The Dollar also plummeted to the lowest level in 16 months against the Euro last night, as the Fed still believe that accommodative policy is still necessary to sustain the economic recovery. Long-term inflation expectations also remain stable and it seems increasingly likely that the FOMC will keep rates at ultra-low levels for the remainder of the year.
The Dollar dropped as the accompanying statement indicated that the rise in inflation is likely to be temporary. The relatively dovish tone of Bernanke’s statement maintained investors’ appetite to sell the Dollar and a move towards 1.4850 followed the press conference during the Asian trading session overnight.
U.K 00:01 – Gfk Consumer Confidence (April)
GER 09:00 – Unemployment (April)
U.S 13:30 – GDP Advance (Q1)
U.S 13:30 – Initial Jobless Claims (w/e 23rd April)
U.S 15:00 – Pending Home Sales (March)