By Jon Beddell
Foreign Currency Market Update – GBP / EUR Update
The big news came from the Euro zone last week. Portugal finally succumbed to its debt woes and went cap in hand to the EU after bond yields rose to unsustainably high levels over the previous week. Prime minister Jose Socrates had already thrown in the towel in the face of the market’s unwillingness to fund new debt issues, pretty much what happened in the lead up to the Greek and Irish bailouts. The announcement was therefore not fully discounted, but neither was it a big shock, allowing the Euro to take it very much in its stride, losing only a few basis points against Sterling before recovering to end the week at five month highs. It’s thought that any rescue package will need to be around €80bn.
The other big story also broke on Thursday. The ECB raised interest rates by 0.25% to 1.25%. That was also very much expected following the hawkish comments made by ECB chairman Jean Claude Trichet last month. The Bank of England kept rates on hold at 0.5%, and expectations of a UK rate hike have receded to June/July at the earliest despite stubbornly high inflation. Sterling looks highly vulnerable based on interest rates alone, offering virtually no yield, and based on recent performance the prospect of capital losses for those holding it! It will take solid evidence of economic improvement and higher interest rates to turn the Pound. One could argue that the Bank of England is happy enough to see a weak pound right now, as this helps the trade deficit by making exports cheaper for foreign buyers. On top of that, higher interest rates are likely to dampen domestic demand and dent tax receipts which works against the coalition’s attempts to balance the budget.
In other news last week UK industrial production contracted by 1.2% in February. Germany’s grew by 1.6%. We have March inflation data out in the UK tomorrow morning, with retail prices expected to maintain February’s 5.5% year on year growth.
The technical outlook is negative. Sterling has broken well below long term trend support and now looks set to test the October low below 1.12. Things could get dramatically worse from here unless we see a fundamental catalyst for improvement. It would take a break above 1.1475 to give use any confidence in Sterling’s ability to turn the tide from here. Clients with Euro requirements should consider covering any exposure now, using a forward contract if necessary.