GBPEUR/GBPUSD

Following on from last week, the Pound fell against the Euro and the Dollar, after the minutes from the Bank of England's November policy meeting showed that policy makers were split three ways on whether to extend the quantitative easing plan and discussed cutting the deposit rate on reserves. The UK currency declined against the Euro for the first time in four days, falling to a low of 1.1100 by close of trading on Friday.

The majority of the nine member monetary policy committee recommended a £25 billion increase in asset purchases, while the chief economist Spencer Dale favoured no change and David Miles sought a £40 billion expansion. Policy makers unanimously kept the benchmark interest rate at a record low of 0.5% on November 5th.

The minutes said that "a reduction in the rate of remuneration relative to bank rate on a proportion of commercial bank reserves would bear down on short-term market rates and could ease monetary conditions further." The committee "agreed that it might be a useful policy tool in some circumstances, and therefore should be available in future."

The decision was the first three way split since August 2008, before the collapse of Lehman Brothers Holdings Inc exacerbated the economic crisis. The MPC has adopted a policy of cohesion over the past couple of months but as the existing plan drew to a close in November, policy makers have broken rank and are clearly swimming in different directions.

A change in the deposit rate would expand the options available to the Bank of England, as they desperately try to pull the economy out of its longest recession on record. Alan Clarke, an economist at BNP Paribas SA, said that "it's very much a case of keeping their options open. These minutes are saying there's arguments in both directions, and it's going to be very data-dependent in the next three months."

The Pound was trading above $1.6800 versus the Dollar prior to the report, but slipped back through the course of the week, amid speculation that policy makers may extend quantitative easing beyond the current £200 billion. Spencer Dale advocated that an increase in bond purchases posed an increased risk to inflation, and "might result in unwarranted increases in some asset prices that could prove costly to rectify."

David Miles argument for a more aggressive increase was that it would "provide greater insurance against the downside risks to growth and inflation arising from constrained credit supply." Policy makers have increased their forecasts for inflation and economic growth over the past month but the Governor Mervyn King said last week that he has an "open mind" about expanding asset purchases further.

The central bank's projections for the next two years show inflation approaching the 2% target even if the bank starts to increase borrowing costs next year. The Pound posted its biggest decline in over a week against the Euro and may continue to lose ground, as investors lack any real direction on the prospects for additional stimulus.

The Pound continued to decline against the U.S Dollar on Friday, amid speculation that UK banks will disclose more credit losses. The Daily Telegraph reported yesterday that UK lenders are in a worse state than those abroad, citing credit-checking company Experian Plc.

A report from the Office of National Statistics showed that the shortfall of £11.4 billion compared to a deficit of just £130 million a year earlier. The median forecast was for a £7 billion deficit and the record amount comes in a month when the Treasury benefits from quarterly payments of taxes on company profits.

Gordon Brown is counting on an economic recovery to help narrow the budget deficit, as concerns grow over the mounting UK debt position. The Bank of England's latest projections show that the economy will probably exit the deepest recession on record in the fourth quarter of 2009. Including the liabilities of banks now controlled by the government, Britain had £829.7 billion of debt in October, roughly 59% of gross domestic product.

Jeremy Stretch, a senior currency strategist at Rabobank International, said that "there are ongoing concerns about the state of the banking sector in the UK and that is weighing on Sterling." The Pound declined 0.2% in value against the Euro yesterday, as losses at banks exacerbated the UK's widening budget deficit.

The Pound headed towards a weekly decline against the majors on Friday, after the UK's biggest business lobby called for "ambitious" reductions in the budget deficit to allow the central bank to keep interest rates low. The UK currency fell to its weakest level against the U.S Dollar in more than a week and traded back towards 1.11 versus the Euro.

Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd, said that "monetary tightening expectations will be taken out and the Pound will drop back." The Pound fell 0.5% to $1.6581, the lowest level since November 12th, as UK stocks headed for a weekly drop, after three consecutive days of declines.

The Pound also came under selling pressure, amid speculation that UK house prices will probably fall next year, and it may take until 2014 for a return to the levels at the 2007 peak of the country's biggest housing boom. Former Bank of England Deputy Governor John Gieve said that the UK economy may have turned a corner, as the Pound's depreciation helps it recover from the worst recession on record.

Gieve said in an interview at the World Economic Forum in Dubai on Friday that "the level of the Pound is going to help the UK to benefit from a resurgence in world manufacturing. It was a very important element in the UK's recovery in the 1930s, and I think it will be important in the next few years."

The Pound has declined 21% against a basket of currencies over the past two years, boosting the prospects for a rebalancing of the UK economy in favour of exports, a sentiment echoed by the Bank of England governor Mervyn King. In terms of economic data, the focus this week will fall firmly on the revised GDP estimates for the third quarter.

The Pound may receive a timely boost as investors anticipate an upward revision to the provisional estimate of a contraction of 0.4%. However, any revisions are unlikely to be sufficiently great to change the view that the UK economy is still lagging behind the U.S and Europe, in terms of the economic cycle.


EUR/USD

The Dollar strengthened against the Euro last week, as global stock markets retreated and diminished demand for higher-yielding currencies. Daragh Maher, deputy head of global foreign exchange strategy at Calyon, said "it's a risk-off day. Equity markets are down, and in that kind of environment the Dollar and the Yen get bid"

The U.S Treasury Secretary Timothy Geithner said that he expects the U.S economic recovery will extend into next year and called on Congress to pass legislation intended to prevent another financial crisis. The Dollar also gained versus the Euro, amid speculation that traders trimmed short positions, after the U.S currency failed to weaken beyond $1.50 per Euro.

The FOMC reiterated on November 4th that they will keep interest rates near zero for "an extended period" while saying that policy will stay unchanged, as long as inflation expectations are stable and unemployment fails to decline. The Dollar rose against all of its major counterparts on Friday, as investors sold shares and bought short-term Treasuries to reduce the chance of losses before the end of the year.

The focus this week in the U.S will fall on the release of the minutes from the last FOMC policy meeting, alongside the latest data in terms of consumer confidence and the Fed's preferred measure of inflation in personal income and spending. In the Euro-zone, the release of the key sentiment and activity survey data for November is likely to dominate and the Euro may be susceptible to swings in risk sentiment.


Data Released 23rd November

EU 08:58 - Flash PMI (November) - Composite - Manufacturing - Services

U.S 15:00 - Existing Home Sales (October)


written by Adam Solomon

Labels: daily-insight