by Adam Solomon
Sterling / Euro and US Dollar exchange rates
Following on from last week, The Pound rallied above 1.14 against the Euro yesterday, while the UK currency bounced back versus the majority of the 16 most actively traded currencies on concerns that the debt crisis engulfing the U.S and much of the Euro-zone increased the appeal of Sterling denominated assets. The diversification away from the Euro and the U.S Dollar has clearly benefited the Pound, despite the obvious concerns surrounding the UK economy.
An index of UK factory orders fell more than initial estimates, while industrial confidence plummeted to a two-year low. The Pound recovered initial losses against the Euro, as the single currency struggled for a second day on Thursday on the threat of contagion to other high-deficit regions in the Euro-zone. The report from the Confederation of British Industry showed that orders fell to minus 10 in July, bolstering the case for the Bank of England to keep interest rates at a record low and fuelling concerns about the economic recovery.
A report earlier in the week showed that the UK economy barely grew in the second quarter with gross domestic product increasing just 0.2% in the three months to June. The key components that make up the economy have all been slowing this year, as the government implemented the toughest public spending cuts in a generation.
The Pound rallied after the GDP figures, purely because the economy stayed above the line which indicates contraction and were released in line with expectations. However, manufacturing and service sector growth continues to struggle, with consumer confidence plummeting in the past month and unemployment rising with the number of public sector job cuts.
As a result, it is difficult to imagine the economy growing at a faster pace in the third quarter and come October we could be talking about a contraction in growth and the immediate need for the Bank of England to extend the bond-purchasing program to support growth. With that in mind, the current rate to buy Euros in the region of 1.12-1.14 may represent a good opportunity to secure the rate, while buying U.S Dollars well above the 1.60 mark may also represent good value.
A separate report last week showed that UK housing demand fell for a third straight month in June and the report is just the latest indication that the economy faces a difficult few months ahead. The Pound came under selling pressure towards the end of the week, after Bank of England policy maker David Miles said that attempts to rein in inflation too quickly would risk denting the economic recovery. In a speech to the London School of Economics, Miles said that the weakness in the UK economy may last “longer than previously thought,” indicating that rates are set to remain unchanged.
The Bank of England’s monetary policy committee have adopted a more dovish stance in recent months with some members discussing the prospect of extending the bond-purchasing program and implementing further quantitative easing measures to support growth. The Pound stayed higher against the Dollar last night, despite the announcement that the U.S Senate approved the extension of the debt ceiling to thwart the threat of a default.
The Pound rallied back above 1.64 against the U.S Dollar, as the improvement in risk appetite curtailed demand for the safe haven currencies. There is a sparse supply of economic data this week but the Bank of England meets again on Thursday with no change in interest rates expected. The focus is on manufacturing and services PMI surveys for July, while producer prices for July is expected to illustrate receding inflationary concerns.
Euro / US Dollar exchange rates
The Euro came under renewed selling pressure on Friday, falling to lows below the 1.4250 level, as peripheral yields in Italy and Spain continued to widen and increase concerns over the threat of contagion. There were also widespread reports on Friday that the EFSF would not be able to distribute emergency funds to Greece in September.
The Spanish government also announced an early General Election for November, which only served to heighten market tension. However, the Euro rallied sharply in U.S trading as concerns surrounding a default continued to undermine confidence in the Dollar. The House of Representatives finally approved a deficit-reduction bill of Friday but this was thrown out by the Senate within 16 minutes as the situation remained deadlocked.
In terms of economic data, the U.S second quarter economic growth figures was weaker-than-expected with an annualized increase of just 1.3% compared with initial estimates of 1.7%. In this environment, the Dollar failed to derive any buying support on growth and budget concerns, despite the deterioration in risk appetite.
Following the weekend negotiations, President Obama announced that a U.S debt deal had been agreed, which provided important relief and dispelled the threat of a default. There were still fears that the proposed spending cuts would not be sufficient to prevent a credit-rating downgrade by Standard Poor’s.
Today’s Exchange Rate Data
EU 08:58 Markit Manufacturing PMI (July)
U.K 09:28 CIPS Manufacturing PMI (July)
EU 10:00 Unemployment (June)
U.S 15:00 Construction Spending (June)
U.S 15:00 ISM Manufacturing (July)