by Adam Solomon
Sterling / Euro and US Dollar exchange rates
The Pound weakened against 15 out of the 16 most actively traded currencies, after a report from the Office of National Statistics showed that the revised estimate of UK gross domestic product slowed by more than initial estimates in the second quarter, while the Bank of England decided to implment further quantitative easing measures to protect the economy from the turmoil in Europe.
The anaemic pace of growth in the three months to June makes it increasingly likely that the UK economy slipped into negative growth during the third quarter and that will prompt renewed concerns over a second recession in three years. Elsewhere, the Pound was given a reprieve by the UK services sector data, which showed a much needed improvement in September. Services activity rose to 52.9 from 51.1 in August and a reading above 50 indicates growth in the sector.
The Pound rallied against the Euro, recovering earlier losses, after Moody’s Investors Service cut Italy’s credit rating by three levels, highlighting the need for the ECB to implement further stimulus measures. The escalating tension surrounding the European sovereign debt crisis and general lack of appetite for high-yielding assets has seen the Australian Dollar weaken significantly against the Pound and the Dollar over the past couple of weeks.
Although the Aussie will be dominated by risk sentiment, there is a general unease surrounding the pace of economic activity in the country and a growing sense that the Reserve Bank will cut interest rates over the coming months. House prices continued to fall in August, dropping 0.4% on the month, taking the annual decline to 3.7%.
However, the Australian and New Zealand Dollars bounced back towards the end of the week, reversing the earlier decline, as Asian stocks extended a worldwide rally, which increased demand for higher-yielding currencies. The German Chancellor Angela Merkel confirmed that she is ready to discuss possible recapitalization of European banks at a summit later this month.
The Pound has declined heavily against all of the 16 most actively traded currencies on Thursday, falling over 1% against the Euro and the Dollar in under a minute, as the Bank of England announced that it would resume quantitative easing and purchase government bonds to the value of £75 billion. There was widespread speculation that policy makers would announce an extension to the bond purchasing plan but the move to purchase £75 billion caught the market by surprise and the volatility that ensued pushed the Pound lower.
The initial decline in Sterling to the lowest level in nine months versus the U.S Dollar was short-lived, as the Bank of England’s decision improved risk appetite and increased traders’ appetite for higher-yielding currencies. The Bank of England also kept interest rates unchanged at a record low of 0.5% for the 28th consecutive month.
The increase in the asset-purchase plan, if any, was expected to be £50 billion but policy makers moved to increase the total amount of quantitative easing to £275 billion. The Bank of England stated that an easier policy was required to meet its medium-term inflation targets, comments which may come as a surprise given that inflation is more than twice the 2% target.
The Bank of England governor Mervyn King was very pessimistic in the tone and language used in a statement last week, particularly concerning the UK and global economy with the outlook damaged by a slower global economy and by the turmoil engulfing much of the Euro-zone. He also stated that the global economy is faced with the worst financial crisis since the Great Depression.
The Pound actually strenghtened by the most in nearly three months against the U.S Dollar, while the UK currency made gains versus 15 out of the 16 most actviely traded currencies. The Bank’s decision to reactiviate the quantitative easing program will help to improve confidence in the UK economic outlook. The Pound continued to recover through Friday, even after Moody’s Investors Service downgraded 12 UK financial institutions.
The Pound rallied back towards 1.16 against the Euro by the close of trading on Friday, amid reports that the German Chancellor Angela Merkel and the French President Nicolas Sarkozy remained divided on how to solve the European debt crisis. The focus this week will fall on the latest UK unemployment figures and the BRC retail sales survey for September.
Euro / US Dollar exchange rates
The Euro generally consolidated ahead of the ECB interest rate decision, although there was a brief spike towards the 1.34 level on reports that the EU commission was backing a more comprehensive recapitalization of the banking sector. The European Central Bank left interest rates unchanged at 1.5%, which was in line with market expectations, although a minority anticipated a cut in rates.
In the accompanying press conference, the ECB President Jean-Claude Trichet, in his final meeting, announced that the ECB would introduce long-term repo operations of 12 and 13 months to help improve liquidity. He also stated that the downside risks to the economy had intensified, but he was very careful not to make a commitment to lower interest rates, with his successor waiting in the wings.
The Euro initially weakened to test support below 1.3250, but then rallied later in the day as risk appetite improved. In the U.S, the latest initial jobless claims data recorded a small increase in the latest weekly figures but the Dollar, after a government report showed that non-farm payrolls increased by more-than-expected in September.
The improvement in labour market sentiment spurned demand for the U.S Dollar as a safe haven and the Pound rose towards 1.56 on Friday afternoon. Payrolls climbed 103,000, after a revised 57,000 increase the previous month, which was also more than initially estimated. Swings in risk sentiment will continue to influence the market this week, while a host of significant economic reports are due for release, including U.S retail sales, the Fed minutes and the ECB monthly report.