by Adam Solomon
Sterling / Euro and US Dollar exchange rates
The Pound weakened against the majors on Tuesday, falling significantly against the Australian Dollar to a low of 1.5246, wiping out all of the gains from the previous month. The UK currency previously surged to a high above 1.63 against the Aussie, as global stock markets slumped on concern that the European sovereign debt crisis would result in a Greek default, while other high deficit nations continue to be at risk.
The Pound bounced back above 1.14 against the Euro, however, as European leaders struggle to meet a one-week deadline for a cohesive plan to solve the region’s debt problems. Sterling fell for the first time in three days against the Dollar, after Ernst Young LLP’s Item Club cuts its UK growth forecast and said the Bank of England should lower interest rates.
Peter Spencer, chief economic advisor to the Item Club, said that “with the recovery grinding to a halt, new measures are now needed. We have figures on the assumption of an early resolution to the crisis gripping the Euro-zone, which may prove optimistic in view of the very slow progress made until now. In that case, the outlook for the UK would inevitably be a lot worse.”
UK gross domestic product will increase 0.9% in 2011 and 1.5% in 2012, compared with July projections of 1.4% and 2.2% respectively. Should European leaders fail to quell the crisis, larger doses of so-called quantitative easing won’t work and the government may need to provide additional support such as tax cuts to boost growth.
The Pound was unable to hold above the 1.58 level and retreated back towards 1.5750 by the close of trading. There was further discussion over the economic outlook and underlying confidence remained extremely fragile, as growth forecasts are lowered again. An increase of this magnitude is unlikely to bolster Sterling support because in the current economic climate, the Bank of England can’t risk raising interest rates and hampering the economic outlook even further.
Higher inflation would have a significant impact on consumer confidence and household spending, as we edge closer to Christmas. The Pound made gains against the Euro on comments from the German government that leaders won’t fulfill any “dreams” of a quick resolution to the sovereign debt crisis at a meeting on the 23rd October. The Euro had been gaining on speculation that leaders were close to an announcement on measures to effectively restore confidence in the European banking sector but the statement has played down speculation of a quick fix.
The Pound declined 0.8% against the Euro yesterday and weakened significantly versus the U.S Dollar following a report from the Office of National Statistics, which showed that UK inflation rose in September to match the highest level in over three years. UK consumer prices rose 5.2% from a year earlier, compared to 4.5% the previous month, and the scale of the increase in inflationary pressures will have a severe impact on consumer spending and the economy as a whole.
With consumer prices rising through 5%, the Bank of England would certainly be raising interest rates if the economy could cope with it. However, policy makers have been forced to increase asset purchases by £75 billion in the past month in the form of quantitative easing to support growth and prevent a second recession in three years. The Pound fell to a low under 1.57 against the Dollar and may struggle to gain support in an environment of risk aversion where traders’ are seeking lower-yielding currencies because of their safe haven appeal.
Despite spiking briefly, the Pound was generally weaker following the data and dipped to lows below 1.5650, as the Dollar also secured wider gains. Markets assumed that there would be no policy response from the Bank of England, as it focuses on demand weakness, especially as the central bank is expecting the inflation rate to fall sharply in 2012.
There were also increased fears of stagflation surrounding the economy and the Pound, which undermined confidence through the course of the day. This morning, the minutes from the last MPC meeting will be watched closely today to assess the depth of central bank pessimism towards the economic outlook and banking sector.
Euro / US Dollar exchange rates
The Euro declined against the U.S Dollar following last week’s biggest advance in more than two years, as Germany remained cautious on the prospects of containing the sovereign debt crisis. The Dollar benefited from the increase in risk aversion, as traders’ flocked to so-called safe haven assets following the statement. Stock and commodity markets also fell and currencies tied to global growth such as the Aussie and Kiwi declined against the Dollar.
The Euro peaked above 1.39 prior to the statement and weakened sharply through the course of the day. The Euro-zone debt crisis will continue to dominate market attention and volatility is liable to increase in the build-up to Sunday’s announcement. The Euro was also affected by uncertainties surrounding the Greek austerity vote and Portugal revised its budget deficit forecasts higher.
In terms of economic data, the Bundesbank warned that that the fourth quarter outlook had deteriorated further, while the latest ZEW business confidence index weakened to a 34-month low and the institute warned that Germany could technically be in a recession. In the U.S, the New York State manufacturing index weakened again for October, the fifth successive monthly decline.
The Euro continued to weaken yesterday, as underlying concerns over the debt crisis persisted and the single currency dipped lows in the region of 1.3650 before finding support. There were further uncertainties surrounding France’s AAA credit rating, after it was put on review by Moody’s. There were fears that EFSF expansion would increase the threat of a credit rating downgrade.
Today’s Exchange Rate Data
U.K 09:30 – Consumer Price Index (September) – RPI
GER 10:00 – ZEW Index (October)
U.S 13:30 – Producer Price Index (September)
U.S 14:00 – TICS Net Capital Inflows (August)
U.S 15:00 – NAHB House Builders’ Sentiment (October)