by Adam Solomon
Sterling / Euro and US Dollar exchange rates
The Pound rallied strongly against the Euro yesterday, rising up through 1.16, after the European Central Bank unexpectedly cut interest rates to 1.25% in the new chairman Mario Draghi’s first meeting. UK government bond fell and stocks rose, as G-20 leaders meet to discuss the Euro-zone debt crisis, amid reports that Greece withdrew a plan for a referendum in the nation’s rescue package.
The FTSE 100 Index of leading UK shares jumped 1.5%, after declining by an equal amount earlier in the day. The level of volatility and uncertainty in the market is set to continue with the outcome of the Euro-zone problem still highly questionable. The fact that Greece will not be holding a referendum has provided a measure of stability to European stocks and the Euro has bounced back towards 1.15 versus the Pound.
The UK currency found support on dips below 1.59 against the U.S Dollar and pushed back to challenge resistance levels above 1.60 as wider volatility ensued. The latest PMI services-sector report was weaker-than-expected with a decline to 51.3 in October, from 52.9 the previous month. Economists had predicted a result of 52.0 but the decline will fuel concerns that the economy is weakening in the fourth quarter and may slip into contraction.
There was an underlying mood of caution within the report and inflation pressures eased, although there was also a modest improvement in business confidence. Markets remained extremely anxious over the UK economic outlook, especially given the negative impact of Euro-zone stresses and further fears over recession conditions.
There were defensive capital outflows into the Pound as a haven from the turmoil in the Euro-zone, which continued to dominate through the course of the day. There will still be fears surrounding the threat of capital outflows from the banking sector, given the pressure on European banks to raise capital and this could still be a crucial factor the Pound.
The European interest rate cut has almost paled into insignificance considering other factors that are affecting the market. The Greek Prime Minister George Papandreou faces a vote confidence today, as he clings to power and there are strong rumours that he will step down today. The Euro is on the front foot now the threat of a referendum has been taken off the table and the positive sentiment following last week’s announcement on the extension to the bailout fund has been recaptured. – Although conditions remain volatile.
Euro / US Dollar exchange rates
The Euro weakened against the Dollar yesterday and extended its weekly decline, as choppy trading conditions and the level of uncertainty weighed on risk sentiment and spurred demand for lower yielding currencies. The ECB cut interest rates for the first time in over two years and there was strong speculation that the Greek Prime Minister would resign.
The incoming ECB President Mario Draghi justified the decision to cut interest rates on the back of a weakening economic outlook and expectations of a mild recession at the end of 2011. Draghi adopted a fairly orthodox stance on monetary policy and said he’s rather cut rates than resort to a form of quantitative easing.
The Euro weakened sharply following the announcement before recovering later in the day. Papandreou abandoned the idea of hold a referendum, amid internal party dissent, and he will aim for a new government including opposition parties following today’s confidence vote. Italian and Spanish bond yields retreated from peak levels, but Italian bonds were still above 6.2%, raising fears surrounding austerity measures within Italy.
There was a further strong suspicion of capital repatriation by weaker European banks, which was putting underlying upward pressure on the Euro. The focus today will continue to be on political tensions within the Euro-zone but the U.S non-farm payrolls data will add to the volatility and the report is expected to show that up to 100,000 jobs were added in October.
Today’s Exchange Rate Data
EU 08:58 – Markit Services PMI (October) – Composite
EU 10:00 – Producer Price Index (September)
GER 11:00 – Industrial Orders (September)
U.S 12:30 – Non-Farm Payrolls (October) – Unemployment – Average Earnings