by Adam Solomon
Sterling / Euro and US Dollar exchange rates
Following on from last week, the Pound declined against the Euro on Thursday, amid a sense of optimism that progress is being made on agreeing a plan to effectively tackle the European sovereign debt crisis and restore confidence in Euro-denominated assets. The UK currency was trading lower versus the majority of the 16 most actively traded currencies, as the Pound’s appeal as an alternative to the Euro waned in the build-up to Sunday’s deadline.
Preliminary reports indicated that changes to Europe’s revamped bailout fund will be finalised this weekend and may open the door to “massive” credit lines for countries with high debt levels like Italy and Spain. The Pound found a degree of support from a government report, which showed that UK retail sales unexpectedly rose by the most in five months in September, reducing concern that the economy is hurtling towards a recession.
Sales climbed 0.6% from August, when they plunged a revised 0.4%, as the Bank of England extended monetary stimulus to help support the economy. House hold spending has been weak for some time as tension in global financial markets have a damaging effect of consumer confidence. Consumer spending is likely to be further hampered with inflation rising to 5.2%, led by higher gas and electricity costs.
The minutes from the Bank of England’s last policy meeting showed that officials were unanimous in the decision to expand the size of the quantitative easing plan to £275 billion this month. The Central Bank also indicates that growth will continue to be subdued and is expecting gross domestic product to be close to zero in the fourth quarter.
The level of joblessness has also increased in the past month with the number of unemployed rising to 2.57 million in the three months through to August, the most since 1994. The Pound remained largely unchanged against the majors, after a report showed that UK consumer confidence fell for a fourth in September, led by the increase in unemployment.
The Pound weakened 0.3% against the Euro and also lost ground versus the U.S Dollar, as signs emerged of a French-German split on a plan to resolve the debt crisis, which spurred demand for the U.S currency as a safe haven. The Pound is likely to trade between a range of 1.50 and 1.55 against the Dollar over the next quarter, as confidence remains fragile.
The UK and Euro-zone banking sectors will continue to be an extremely important focus in the near-term. There will be speculation that Euro-zone banks will put funds out of the UK in order to bolster capital ratios and this would risk further serious damage to the UK economy. The Pound has benefited from its position outside the Euro-zone and made strong gains against the Euro overnight, as the deadline for any announcement was extended to Wednesday.
The Pound found support in the region of 1.5750 against the Dollar on Friday and rallied strongly to a peak near 1.5950, as the UK currency broke through significant resistance levels. The latest government borrowing figures was slightly better than expected with a deficit of 11.4 billion for September. For a second successive month, there was a significant revision to the previous month’s data, which will ease fears surrounding the immediate budget outlook.
There is little in the way of economic data released this week and the markets will be watching the latest comments from the Bank of England governor Mervyn King on Tuesday. The focus will continue to be on developments in the Euro-zone with particular attention on the banking sector. A potentially toxic development would be the withdrawal of funds from the UK by European banks.
Euro / US Dollar exchange rates
The Euro rallied higher against the Dollar last week, as optimism over a solution to the debt crisis pushed the single currency above 1.3820. The move was not sustained, as reports emerged that Germany and France were at odds over the details over the revision of the EFSF and a subsequent delay to any announcement to this Wednesday.
Italian bond yields continued to rise and approached the 5% level on Thursday. The IMF-led Troika report on Greece was published and it was concluded that the situation was more difficult than expected, as a deeper recession put further downward pressure on tax revenues. Significantly, the Troika still recommended that the next loan tranche should go ahead as planned.
There were reports on Friday that France had backed down on demand for the EFSF to be made a bank with the German government unable to deliver necessary support from the Bundestag. There was also outline agreement on plans for around €100 billion in bank recapitalization with official assistance to banks who were unable to raise capital privately.
Today’s Exchange Rate Data
EU 08:58 – Flash Markit PMI – Manufacturing (October) – Services / Composite
EU 10:00 – Industrial Orders (August)