by Adam Solomon
Sterling / Euro and US Dollar exchange rates
Following on from last week, the Pound declined against the Euro and the US Dollar exchange rates on Thursday, while the UK currency bounced back aggressively from a record low versus the Swiss Franc, after the SNB pledged immediate measures to calm the currency’s relentless gain, even a temporary peg with the Euro was discussed. The Bank of England’s quarterly inflation report showed that the economic outlook is worsening in the UK and the governor Mervyn King gave an indication that policy makers can expand monetary stimulus at any time if growth deteriorates further.
It is beginning to looking increasingly likely that the economy will slip into negative growth in the third quarter and that may prompt the BoE to begin bond-purchasing again through a means of quantitative easing. A level of stability returned to financial markets following a volatile few days last week, as global risk appetite improved following the rise in global equity markets.
The higher-yielding currencies subsequently gained ground versus the majors with the Australian and New Zealand Dollars strengthening versus all of the 16 most actively traded currencies. The Pound encountered strong resistance in the region of 1.63 against the U.S Dollar and maintained a weaker tone through the course of the day on Thursday, before bouncing back above 1.62 on risk sentiment.
The Bank of England also downgraded its growth forecasts for 2012, cutting it to around 2% from 2.5% previously. The GDP estimate of 1.4% for 2011 seems too overly optimistic at present and there is a likelihood that it will be downgraded further. The governor Mervyn King also warned that inflation is likely to rise above 5% over the coming months, before receding next year. There is, however, a very small chance of a rate increase before June 2012, due to concerns about the sustainability of the economy.
There is widespread speculation that France will suffer a downgrade in its AAA credit rating, renewing concern that Europe’s sovereign debt crisis is spreading to the larger economies in the Euro-zone. RBS Plc and HSBC Holdings Plc lost more than 5% in trading on Thursday, as the benchmark FTSE 100 Index tumbled more than 3.1%.
The UK finance minister George Osborne addressed parliament and reassured investors that the UK won’t suffer a credit rating downgrade like the U.S and possibly France. The Chancellor also rebuffed opposition demands to review the spending cuts and the deficit reduction plan, as the debt crisis in Europe increased the volatility in global equity markets.
The worst civil unrest in 30-years has been largely blamed on the public spending cuts, which has increased public-sector job losses and seen consumer confidence plummet to the lowest level in years. The Pound strengthened against the Euro on Friday, bouncing back from an earlier low of 1.1310, to peak above 1.14 by the close of trading.
Although the government is stubbornly backing the deficit-reduction plan at this stage, it will be interesting to the see how the coalition party will react if the economy slips into negative growth later this year. Following Osborne’s statement, the Pound appreciated against 8 of the 16 most actively traded currencies.
With the U.S economy downgraded from the AAA status and the Euro-zone debt crisis spreading, the UK has become a relative safe haven for investors from the turmoil. The Pound appreciated 0.4% against the Dollar, despite the lack of confidence in the UK economy, especially with the Bank of England likely to keep interest rates low for longer.
The UK banking sector will be watched closely over the coming weeks and the Pound will be vulnerable to further selling pressure if there is any evidence of a deterioration in credit conditions. The data released this week will be closely watched, with UK consumer prices expected to edge higher at 4.3% year-on-year in July.
UK retail sales are expected to show a modest 0.3% improvement over the same period, while the latest unemployment data is expected to show the claimant count increased 20,000 in July, from 24,500 the previous month. Other data of note includes average earnings, which is expected to remain unchanged, and house prices for August. Any comments from ratings agencies will also be heavily scrutinised and there will be speculation of a downgrade if there is any evidence of a further deterioration on economic conditions.
Euro / US Dollar exchange rates
The Euro exchange rate recorded a second consecutive weekly drop against the Dollar, after reports showed sluggish growth in Euro-zone industrial production, while Greece’s economy contracted. The single currency made its biggest weekly drop in three months versus the Japanese Yen, amid speculation that the ECB will be forced into cutting interest rates to support growth.
Volatility in financial markets remains extremely high and both the Euro and the Dollar are struggling to gain support, amid concerns surrounding structural vulnerabilities in both economies. There was further buying of Italian and Spanish bonds by the ECB on Thursday, which helped keep yields down, although credit-default swaps in France continued to rise.
In the U.S, the number of Americans filing for first time unemployment benefits was marginally less-than-expected with a decline of 395,000, from 402,000 previously. The trade data showed that the deficit increased to $52.1 billion in June, as exports registered the biggest decline in two years, underlining concerns about the economy.
The Euro exchange rate again found support in the region of 1.4150 against the Dollar and rallied to close to 1.43 by the close of trading on Friday. U.S retail sales provided a degree of relief from the recent gloom with the headline figure rising 0.5% on the month in July. However, the University of Michigan’s consumer sentiment index was sharply weaker-than-expected, falling to the lowest reading since 1980.
Today’s Exchange Rate Data
U.K 00:01 – Rightmove House Prices (August)
U.S 13:30 – Empire State / NY Fed Index (August)
U.S 14:00 – Net Capital Inflows (June)
U.S 15:00 – NAHB House Builders’ Sentiment (August)