Pound, Euro & US Dollar Currency Forecast – The Pound initially rallied against the majors yesterday in the foreign exchange rate markets


by Adam Solomon

Sterling / Euro and US Dollar

Following on from last week, 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 will continue to weaken the Pound.

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 first quarter data 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.

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.

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 last week that the average selling prices for factories reached the highest level since January 1990.

The Pound took advantage of broad Dollar weakness last week, 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.

The Pound fell back towards near-term support in the region of 1.12 on Friday and even weakened against the U.S Dollar in anticipation of a report this morning, which is forecast to show that UK manufacturing growth declined to the lowest level since October. The UK currency recorded sharp losses against 14 out of the 16 most actively traded currencies in the build up to this morning’s report.

Elsewhere, the Confederation of British Industry is expected to report that a measure of UK retail sales remained unchanged last month, as consumer confidence remains fragile. The Pound is also struggling following comments from the Governor of the Bank of England Mervyn King, who said that higher interest rates would exacerbate the debt problems in the UK.

To that end, investors are speculating that UK interest rates will remain on hold at a record low of 0.5% until 2013, as the economic recovery struggles to gain momentum. That’s the view of Deloitte and Touche LLP, as the former advisor to the UK Treasury Roger Bootle said that “the underlying momentum of the economic recovery looks pretty weak. My central forecast is still that rates remain on hold throughout this year and next.”

The Bank of England will meet again this week and no change in policy is expected, after the minutes from the previous meeting showed that the MPC are still prepared to adopt a “wait-and-see” approach. This will be Andrew Sentance’s last opportunity to vote for a rate increase before his term on the panel ends on the 31st May.

Euro / US Dollar

The Dollar plummeted to the lowest level in 16 months against the Euro exchange rate last week, as the Fed still believe that accommodative policy is 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 on Thursday.

The Dollar also came under pressure against the Euro, after a decline in U.S manufacturing reinforced speculation that the Fed will keep rates on hold, while the ECB looks set to raise rates once more. The Dollar Index dropped for a tenth straight day in its longest slump in 17-years and the Euro has gained before the ECB interest rates announcement on Thursday.

Data Released

U.K 09:28 – CIPS Manufacturing PMI (April)

EU 10:00 – Producer Price Index (March)

U.K 11:00 – CBI Distributive Trades Survey (April)

U.S 15:00 – Factory Orders (March)

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