by Adam Solomon
Sterling / Euro and US Dollar
Following on from last week, the Pound declined heavily against the U.S Dollar, falling to a fresh two-month low, but political deadlock in Europe saw the Euro exchange rate unable to capitalize on a renewed bout of Sterling weakness. The UK currency traded down towards a low of 1.6110 against the Dollar last week, after reports showed that UK jobless claims surged by more-than-expected in May, while wage growth remained subdued.
Reports earlier in the week showed that inflation remained at the highest level in over two years in May, while rising unemployment and slower wage growth will inevitably have a negative impact on consumer confidence and damage the outlook for the UK economy. Higher unemployment also reduces the prospect of an increase in UK interest rates this year with some investors pointing to the risk of a second quarter contraction.
The conflicting economic data will do little to inspire confidence and the lacklustre pace of the economic recovery will continue to undermine confidence in the Pound. The UK currency extended its decline against the U.S Dollar. In his mansion speech on Wednesday, the governor of the Bank of England Mervyn King maintained a generally downbeat assessment on the UK economic outlook and also referenced to very weak growth in money supply.
The Pound remained vulnerable on yield grounds, although international trends dominated with wider Dollar gains pushing the rate lower. The UK banking sector will remain an important focus and there will be further concerns over renewed losses if EU governments cannot prevent debt defaults. However, for that reason the Pound continued to trend higher against the Euro, rising to a high of 1.1450.
The Pound continued to trade lower against the U.S Dollar towards the end of the week, while the UK currency also came under renewed selling pressure versus the majority of the 16 most actively traded currencies. A report from the Office of National Statistics showed that UK retail sales dropped more-than-expected in May, led by higher fuel costs and ongoing concerns about the labour market.
Consumer spending rose in April, which coincided with extra bank holidays and the Royal wedding. However, sales fell 1.4% in May, wiping out the 1.1% gain the previous month. The Pound declined and bonds rose after the report, as UK consumers are being squeezed from rising inflation outpacing wage growth, while consumer sentiment is being undermined by government spending cuts.
The Bank of England governor Mervyn King said earlier this week that the economy is undergoing rebalancing that will take several years, as he justified the Bank’s decision to keep interest rates on hold to aid the recovery. The Central Bank’s credibility has been called into question this year with UK inflation accelerating at the fastest pace in two years and likely to breach 5% over the coming months.
The monthly drop in UK retail sales was the biggest since January 2010 and excluding fuel, sales fell 1.6% on the month and were unchanged on the year. Reports earlier this week also showed that unemployment claims surged to the highest level in almost two years in May and wage growth was an annual 1.8% in the three months through April.
The Pound has weakened significantly against the majors, as investors continued to scale back expectations that the Bank of England won’t raise interest rates before May 2012. As recently as February, investors were anticipating an increase in UK borrowing costs in May this year. The UK currency will encounter strong support in the region of 1.60 against the Dollar, but an improvement in risk appetite could see the market bounce higher once-more.
The Pound declined against the majority of the 16 most actively traded currencies through the day on Friday, as concerns grew over the bleak outlook for the UK economy. The FTSE 100 Index swung between gains and losses but the Pound bounced back above 1.6150 against the Dollar by midday, after the French president Nicolas Sarkozy said a “breakthrough” has been made on a resolution to the Greek debt crisis.
The subsequent improvement in risk appetite saw the Dollar decline against the Pound and the Euro, amid suggestions that a solution involving holders of Greek bonds in a rescue package for the struggling nation has been found. The Euro also made strong gains against the Pound, increasing 0.5%, as the focus turns to the possibility of an ECB interest rate increase next month.
The focus this week in terms of economic data will fall on Wednesday’s release of the minutes of the June policy meeting. Policy makers left interest rates on hold at a record low of 0.5% but markets will be looking for changes in the voting pattern now that Andrew Sentance has left the committee. He was replaced on 1st June by Ben Broadbent who is thought to retain a move dovish stance.
Euro / US Dollar
The Euro dropped to a one month low against the U.S Dollar on Thursday, as the EU struggled to break the deadlock over a second Greek rescue package. The Dollar also benefited from data that showed the cost of living in the U.S rose by more-than-expected in May, reflecting higher price pressures in the economy and boosting optimism that the FOMC will have to raise interest rates to combat inflation.
The Euro exchange rate also came under pressure after the Greek Prime Minister lost political support and the European Union struggled to break a deadlock on a second financial rescue package for the struggling nation. The Euro lost ground against the vast majority of the 16 most actively traded currencies, as the uncertainty over European sovereign debt continued to undermine confidence.
The ECB President Jean-Claude Trichet stated that markets must avoid compulsion and triggering a credit crisis in any restructuring of Greece’s debt. There were also fresh concerns over further damage to the European banking sector and sentiment is likely to remain weak, putting further pressure on the Euro in the short-term.
However, the comments on Friday from the French President Nicolas Sarkozy that a “breakthrough” has been made on a resolution to the Greek debt crisis helped improve sentiment for the Euro. Crucially, the German Chancellor Angela Merkel suggested that any debt restructuring must be done on a voluntary basis. The German shift in stance eased immediate concerns that Greece would be pushed to default.
In meetings over the weekend, EU officials stated that they would continue to work on a new support package for Greece, but no decisions were made. Market confidence will inevitably remain fragile given the severe doubts whether Greece would be able to deliver on austerity measures. The focus this week will fall on the FOMC rate announcement this week with no change expected in policy.
U.K 00:01 – Rightmove House Prices (June)
EU 09:00 – Current Account (April)