by Adam Solomon
Sterling / Euro and US Dollar exchange rates
The Pound rallied to a fresh high above 1.17 against the Euro exchange rate in early trading yesterday, while the UK currency plunged towards the lowest level since January versus the Euro, amid a drop in global stock markets, which boosted demand for lower-yielding currencies. Investors have added to bets that the Bank of England will this week announce further monetary stimulus to bolster the economy and support growth.
The UK economy barely grew in the second quarter and official figures released later this month may show that GDP fell into contraction territory during the third quarter. A report yesterday showed that manufacturing actually expanded in September, but reports yesterday showed that growth in the construction industry slowed more-than-expected, strengthening the case for additional stimulus measures to be introduced.
The Euro declined against the Pound and the Dollar, after European policy makers said they are weighing up imposing further losses to Greek bondholders. The Pound remained under pressure against the U.S Dollar, testing support just under 1.54, close to the lowest level in 14 months. The UK currency also declined against the Euro later in the day, as exporters took advantage of recent Sterling gains.
The decline in confidence following the dismal construction figures yesterday may be exacerbated by the services PMI this morning and the outlook may deteriorate even further if there is a weaker-than-expected result. A figure below 50 would see the Pound vulnerable to heavy selling pressure, as speculation will mount over a second recession in three years.
The minutes from the Bank of England’s last policy meeting suggested that it is becoming “increasingly probable” that another round of government bond purchases may be needed to boost the economy. The Chief economist Spencer Dale said in a newspaper interview last week that the MPC has the necessary tools to provide additional monetary easing if conditions deteriorate.
Three members of the Bank’s monetary policy committee have publicly discussed the potential need for additional stimulus measures to be introduced, with Adam Posen raising his recommendation for the amount of stimulus required. The Pound is likely to weaken in the build up to Thursday’s announcement, as speculation increases of a move towards further QE.
Standard Poor’s have reaffirmed the UK’s AAA credit rating and said that the outlook is stable according to a statement released earlier this week. The ratings agency described the UK as having a “wealthy, open, and diversified economy, supported by a well-established political system and macroeconomic policy framework, which can react quickly to economic challenges.”
The statement will only serve to encourage the government to proceed with the deficit-reduction plan and follow through with the full extent of the cuts, despite concerns over an imminent recession. The UK chancellor George Osborne has proposed lending billions of public money directly to companies struggling to obtain credit from banks as means of supporting the economy.
A report from the British Retail Consortium earlier this morning showed that UK shop price growth was unchanged in September. Prices rose 2.7% from a year earlier, the same pace as in August, which suggests that inflation is stagnating, without the need for an interest rate increase. The Bank of England has predicted that inflation will reach 5% this year, squeezing household’s disposable income and weakening the economy.
Euro / US Dollar exchange rates
The Euro slumped against the Dollar yesterday on speculation that mounting debt concerns and signs of economic slowdown will compel the European Central Bank to increase monetary stimulus at its meeting tomorrow. The single currency found support in the region of 1.3150 area but recovered strongly through the course of the day.
There is a continuing lack of confidence in Greece with strong expectations of a medium-term default, especially after the decision on the next loan payment to be delayed until November. The Greek government stated that it had enough funding until mid-November, but there were still strong expectations of a much bigger private-sector debt write-down as part of a repackaged rescue deal.
The Euro also found buying support, as the ECB chairman Jean-Claude Trichet defended the use of non-standard measures in testimony to the French parliament. He was also less dovish in tone than expected on the Euro-zone economic outlook, which dampened immediate speculation of a cut in interest rates at Thursday’s meeting.
Today’s Exchange Rate Data
EU 08:58 – Markit Services PMI (September) – Composite
U.K 09:28 – CIPS Services PMI (September)
U.K 09:30 – Final GDP (Q2)
EU 09:30 – Revised GDP (Q2)
EU 10:00 – Retail Sales (August)
U.S 13:15 – ADP Employment (September)
U.S 15:00 – ISM Non-Manufacturing (September) – Business Activity