by Adam Solomon
Sterling / Euro and US Dollar exchange rates
Sterling slumped to the lowest level since January against the U.S Dollar, after turmoil engulfing global stock markets increased demand for safe haven currencies. The minutes from the Bank of England’s last policy meeting showed that policy makers may need to extend quantitative easing measures to support the economy and keep borrowing costs low. The UK currency also slumped for the first time in four days versus the Euro as the minutes also revealed that officials expect growth in the second half of the year to be much weaker.
There is an increased likelihood that the UK economy slipped into negative growth during the third quarter and the Pound is declining on the prospect of further stimulus measures to be introduced by November. The UK Business Secretary Vince Cable reiterated the need for the Bank of England to act and buy assets other than government bonds.
The Pound also declined against the majors, as an industry report showed UK consumer confidence dropped to the lowest level in four months in August. The decline in confidence follows the worst civil unrest in thirty years during August, while gauges of manufacturing, services and construction also declined.
There is a high degree of uncertainty surrounding the outlook for the UK and indeed the global economy and speculation over another recession is also weakening demand for the Pound, particularly against the lower-yielding currencies like the Dollar and the Yen. The UK currency declined to a low of 1.5450 against the Dollar on Friday, the lowest level since January 11th.
The minutes also showed the voting pattern was 8-1 to maintain the current size of the bond-purchasing plan and was unanimous on keeping interest rates unchanged at 0.5%. However, policy maker Adam Posen, who has voted to increase quantitative easing measures every month this year, increased his recommendation to £250 billion worth of stimulus.
Investors are also betting that the Bank of England will keep interest rates on hold until after July 2012. Elsewhere, a report from the Office of National Statistics showed that Britain had its biggest budget deficit for any August since modern records began in 1993, as government spending increased and income tax receipts declined. The shortfall of £15.9 billion, compared with £14 billion a year earlier and the increase may jeopardise the UK’s AAA credit rating.
There is also speculation that the government will have to shift fiscal policies given the deterioration in the economic outlook. The weaker outlook for domestic and global growth had an important negative impact on confidence, amid fears that the UK debt burden could trigger a further downturn in economic activity. The latest CBI Industrial orders data provided no support to Sterling, weakening to -9 from 1 previously.
The Pound found support just below 1.54 over the weekend and the UK currency looks set for further losses, as the UK BBA mortgage lending data was marginally stronger-than-expected, which inspired a degree of confidence in the housing sector. The data didn’t have a big impact on the market amid international developments elsewhere, which continued to dominate.
There were hopes that Euro-zone leaders would push towards a re-capitalisation of the banking sector and this would tend to provide a degree of relief to UK banks. The Pound also gained support from being outside the Euro-zone, as any burden of supporting weaker Euro-zone countries would not fall on the UK.
There will be very important concerns surrounding the UK economy with increasing pressure for additional quantitative easing by the Bank of England. Nevertheless, the Pound advanced towards 1.15 again against the Euro in early trading this morning and a move higher seems likely this week.
Euro / US Dollar exchange rates
The Euro encountered strong support below the 1.3650 level against the Dollar on Wednesday and strengthened to highs above 1.3750 towards the close of trading. There was a degree of relief over the Greek debt situation and the threat of default, as the government pledged to increase austerity measures through additional spending cuts.
There were still major concerns about whether the government would be able to deliver the cuts considering the extent of divisions and popular discontent but the move helped provide near-term support to the Euro. There were continuing fears surrounding the banking sector as underlying stresses persisted. The IMF estimated that at least €200 billion would need to be raised and there were fears over the level of debt at French banks.
The latest FOMC statement said that the Fed will be buying $400 billion in longer-dated securities in the period until Mid 2012 through the selling of shorter-term securities. The Fed also announced that it would target mortgage-backed securities in an attempt to keep mortgage rates down. There was, however, no introduction of further quantitative easing measures at this stage with the Fed remaining downbeat on the economic situation.
Global stock markets fell sharply following the meeting, triggering a sharp deterioration in risk appetite and pushing the Dollar stronger against the majority of the 16 most actively traded currencies. The Euro came under fresh selling pressure yesterday, retreating sharply to lows near 1.3420, the lowest level since February.
Underlying confidence in the Euro-zone economy will continue to deteriorate and there was additional pressure for more decisive action at the IMF and G-20 meetings over the weekend. There is continuing speculation that Greece would default and there are concerns over the Euro-zone banking sector that will continue to undermine the Euro.
Today’s Exchange Rate Data
GER 09:00 – Ifo Sentiment Survey (September)
U.S 15:00 – New Home Sales (August)