The Pound Sterling strengthened to the highest level against the Euro exchange rate since March

Foreign Exchange Rates Currency News - The Pound strengthened to the highest level against the Euro exchange rate since March

by Adam Solomon

Sterling / Euro and US Dollar exchange rates

The Pound strengthened to the highest level against the Euro since March yesterday, while the single currency also tumbled versus the Dollar, as political turmoil in Italy stoked concerns and improved the Pound’s position as a haven from the crisis. Italian bonds slumped again, driving yields above the 7% barrier for the first time since the Euro was introduced in 1999.

In an historic day’s trading, the Euro plunged versus the majority of the major currencies, as the Italian Prime Minister Silvio Berlusconi offered to resign and left the nation seeking a government capable of restoring confidence while implementing austerity measures to reduce borrowing costs. Italy is Europe’s third largest economy and is being crippled by toxic debt and political indecision.

The ongoing turmoil in the Euro-zone has been like a dominos effect, after the Greek Prime Minister George Papandreou announced a referendum to be held last week before withdrawing his recommendation and resigning over the weekend. Italian yields have been edging higher and higher for the past few weeks and the move above 7% will stoke concern that the nation will default on its debt.

The subsequent increase in risk aversion saw the Pound fall sharply against the U.S Dollar, as weaker-than-expected economic data and escalating concerns in Europe sparked flight to safety for investors. The Pound weakened to lows around 1.59 against the Dollar and also lost ground versus the Yen. The latest trade balance figures were worse than expected with the deficit at £9.8 billion.

Export growth remained subdued and import demand increased. The data will increase fears over a downward revision to the third quarter GDP data, although the overall impact is likely to be measured at this stage. The Pound continued to derive defensive support from safe haven flows from the Euro-zone, as confidence continued to deteriorate.

Global stock markets slumped overnight with Asian stocks down almost 4% as tensions in Europe escalate. There were also fears surrounding the UK economy, as there would be a serious impact from a Euro-zone recession. In this context, there is some speculation that the Bank of England would consider additional quantitative easing at this lunchtime’s meeting and market volatility is likely to be at elevated levels.

Euro / US Dollar exchange rates

The Euro traded lower against the majors yesterday, falling sharply through 1.36 versus the U.S Dollar, as the Italian situation deteriorated rapidly. There was a surge in Italian bond yields, as Prime Minister Silvio Berlusconi’s resignation promise failed to boost confidence and bring stability to the market. Benchmark yields rose through 7% to a record high, a pivotal level which helped trigger rescue packages for Greece, Portugal and Ireland.

The very sharp increase in yields will inevitably leads to fears that Italy would also require multilateral support. The problem is that Italy is the third largest global bond market and there would need to be huge financial commitment to stabilize conditions. The EFSF is very unlikely to have sufficient resources even if it can secure additional leverage and this would increase pressure for IMF support.

This development will put strong pressure on the ECB to increase bond purchases in a form of quantitative easing, but policy makers are expected to display major resistance to such a move. There is speculation that Euro-zone government would need to consider other solutions to the debt crisis such as the creation of narrower Euro-zone.

Today’s Exchange Rate Data

U.K 12:00 – BoE Interest Rate Announcement

U.S 13:30 – Trade Balance (September)

U.S 13:30 – Initial Jobless Claims

U.S 19:00 – Federal Budget

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