by Adam Solomon
Sterling / Euro and US Dollar
Following on from last week, the Pound declined heavily against all of the 16 most actively traded currencies, after the minutes from the Bank of England’s last policy meeting showed that only two members voted to increase interest rates in June. The chief economist Spencer Dale and policy maker Martin Weale kept up their recommendation for an immediate 25 basis point increase to combat inflation, which has risen at the fastest pace in more than two years.
Andrew Sentance left the MPC on 31st May and his replacement Ben Broadbent seems to have adopted a more dovish stance, voting to keep rates unchanged at 0.5%. The prospect of UK rates remaining at a record low for the foreseeable future has weakened the Pound. The UK currency traded down towards 1.12 against the Euro and 1.6050 versus the Dollar.
Sterling also sank below 2.00 against the New Zealand Dollar and further losses appear likely in the short-to-medium term. The Pound may trade under 1.10 against the Euro over the coming months, with the ECB preparing to raise the benchmark lending rate in Europe on the 7th July. The Bank of England was generally quite pessimistic about the economic outlook, warning that weakness in demand was liable to last longer-than-expected.
The minutes also revealed that several members of the MPC actually considered the possibility of further quantitative easing if downside risks to medium-term growth materialised. Without doubt, the minutes have reinforced expectations that interest rates would remain at ultra-low levels this year and there were also further concerns surrounding the UK banking sector.
The results of the BoE minutes were largely factored into the market but the prospect of further quantitative easing and slowing growth has severely weakened Sterling sentiment. It is not inconceivable that given the recent tone of the second quarter data that the UK economy may contract in the three months to June, as the key sectors continue to slow.
The Pound fell below $1.60 against the U.S Dollar exchange rate for first time since April 1st, while the UK currency also lost ground versus the majority of the 16 most actively traded currencies. An index of UK retail sales dropped to the weakest level in a year, further reducing the prospect of an interest rate increase this year. The Pound also slumped as the outlook for the UK economy remains pessimistic and the chances of a second quarter contraction increases.
The Pound briefly bounced back against the Euro exchange rate, as the single currency also declined heavily in the build up to an EU summit in Brussels last week. Finance ministers discussed Greece’s financing needs as the struggling nation drifts closer towards default. Underlying confidence in the UK and the Pound has weakened following comments on the possibility of further quantitative easing in the June MPC minutes.
Although the Bank of England is probably months away from embarking on further bond-purchasing, references to the possibility have clearly undermined sentiment in the UK. Even if quantitative easing is resisted, interest rates are likely to remain at ultra-low levels to support growth, which will also undermine potential yield support for Sterling.
The Pound is likely to remain under pressure, as the focus switches back to UK fundamentals, while the market supports any central bank looking to raise interest rates, with the ECB expected to move in July, underpinning support for the Euro. From a technical perspective, the Pound declined below its 200-day moving average for the first time since January.
The Pound also slumped to the lowest level on record against the Swiss Franc last week, trading at a low of 1.3358 in London. Money markets have scaled back UK interest-rate expectations once more with the overnight interbank average suggesting borrowing costs will be left on hold until August 2012. The Pound traded back below 1.60 against the Dollar again on Friday, even as stocks rose worldwide on reports that the EU has pledged support to Greece.
Given the Pound’s negative reaction to the minutes last week, the UK currency will be vulnerable to any signs of weakness in this week’s round of economic data. Manufacturing for June, mortgage approvals and consumer credit for May will feature, along with consumer confidence and housing data. The focus this week will fall on the final estimate of UK gross domestic product for the first quarter.
Euro / US Dollar
The Euro exchange rate found support close to 1.4350 against the U.S Dollar and again tested resistance above 1.44 ahead of the FOMC meeting last week. There were no surprises as the Fed left interest rates unchanged at a range between zero and 0.25%. There was also a downgrading of U.S growth forecasts for 2011 to 2.7% from 3.1% previously.
The Fed expressed some concerns over price increases but it expected inflation to fall or remain below the level consistent with full employment. The FOMC also said that interest rates would remain unchanged for an extended period and suggested that further quantitative easing could still be considered in the medium term.
The Fed chairman Ben Bernanke declined to make any direct references to further quantitative easing and the main message was there was a high degree of uncertainty over the situation. The Dollar gained in support on relief that there was no direct mention of further QE. In the Euro-zone, there were further discussions surrounding the Greek debt situation and the government will hold a parliamentary vote on reform measures this week, while the EU will decide in the next aid package on July 3rd.
The Euro exchange rate continued to decline further against the U.S Dollar on Thursday and selling pressure accelerated in the U.S session with the single currency falling to lows below 1.4150. The uncertainty surrounding the European outlook and escalating concerns over sovereign debt in other peripheral economies has undermined confidence in the Euro.
The EU and the IMF announced that they had reached an agreement with the Greek government over a five year austerity package. Approval of the plan would secure a new €120 billion bailout for Greece, which would prevent an immediate debt default. The Euro recovered after the announcement but there will still be a high degree of uncertainty.
The Greek government will need to secure parliamentary support for the measures on Tuesday and an agreement is far from guaranteed, especially with the opposition party failing to back planned tax increases. In the U.S, the Dollar is being supported on the decline in risk sentiment with the economic data taking a back-seat.
In terms of economic data in the Euro-zone, the focus this week will fall on the EC sentiment surveys for June and the flash estimate of European inflation for the same month. Key data ahead of the ECB interest rates announcement next month, the headline rate of inflation is expected to remain at elevated levels and the data will reinforce expectations of a rate increase next month.
U.S 13:30 – Personal Income / Consumption (May) – Core PCE