by Adam Solomon
Sterling / Euro and US Dollar
The Pound bounced back above 1.63 against the U.S Dollar yesterday in the currency exchange rate markets, as investors increased bets that the Bank of England would raise interest rates before the Federal Reserve. Recent economic data, combined with some commentary from BoE officials has increased speculation that the MPC will raise borrowing costs from 0.5% by June.
In contrast, the Federal Reserve has maintained a cautious tone in the recent FOMC statement, with the chairman Ben Bernanke refusing to rule out the possibility of further quantitative easing to support the economy. The Fed is expected to keep its benchmark rate on hold in a range between zero and 0.25% until 2012 and that will further enhance the yield advantage that the UK has enjoyed over the U.S, making the Pound a more attractive commodity.
The UK currency pushed towards a high close to $1.6340 against the Dollar in European trading, but there was a sharp reversal during the U.S session, as the Pound retreated to lows below $1.62. The UK currency also slumped under 1.16 versus the Euro, amid reports that Bank of England policy maker Andrew Sentance will be replaced on the MPC after May.
Sentence’ term ends on May 31st and the BoE announced yesterday that Goldman Sachs Inc Managing Director Ben Broadbent will replace him on the committee. The Pound came under immediate selling pressure as the news broke, principally because Sentance has been pushing for an interest rate increase for the past nine months in a row and voted for a 50 basis point hike in February.
Reports that he will be leaving the Monetary Policy Committee has taken away one of the hawks of the Bank of England and replaced him with an unknown quantity. Sentance’s departure will affect the outlook for UK interest rates over the coming year, with analysts at Goldman Sachs predicting that the MPC will leave rates unchanged until 2012, despite persistently high inflation.
The Pound sank to a low of 1.1580 against the Euro exchange rate yesterday and further downside moves appear likely, amid speculation that the European Central Bank will raise interest rates before the Bank of England. Europe has endured inflation above the 2% threshold for the past three months plus concerns surrounding the impact of wage growth, while the UK has put up with inflation double the government’s 2% target due to rising consumer prices.
The recent strength of the Euro was accelerated by Trichet’s hawkish statement on inflation last week where he gave a firm indication that the ECB’s governing council will increase the benchmark lending rate from a record low of 1%. The Pound was down 0.3% against the Euro by the close of trading last night, but money markets still anticipate an increase in UK rates by June.
Any suggestions to the contrary will tend to undermine the Pound and the risks are firmly weighted to the downside. The Confederation of British Industry said yesterday that rate increases will probably come at a “slow and steady” pace in the next quarter to prevent rising inflation from becoming entrenched in the “national psyche”.
The Pound received a timely boost overnight after a report from the Royal Institution of Chartered Surveyors said that UK house prices rose for a fourth straight month in February, as demand increased. The number of real-estate agents saying that prices fell exceeded those reporting gains by 26 percentage points, down from 31% in January.
Recent economic data on the UK housing market has been mixed, with banks reining in lending and the prospect of the largest government spending cuts in a generation casts doubt over the economic outlook. The Nationwide Building Society said last week that house prices rose in February, while the Halifax and Hometrack Ltd reported that prices declined.
Bank of England policy makers will convene again on Thursday and are expected to keep interest rates on hold at 0.5%. Three members of the MPC voted for an immediate increase in borrowing costs last month, as consumer prices hit 4%, the fastest pace of inflation in over two years. Some policy makers believe that a rate increase at this stage would be “self-defeating” but the committee is nearing a majority vote for a hike.
Elsewhere, the Pound approached the lowest level in five weeks against the Euro during the Asian trading session, after a separate report from the British Retail Consortium showed that retail sales declined in February. The 0.4% decline in sales last month followed a 2.3% gain the previous month and there has been evidence of a significant slowdown in sales over the past month.
Euro / US Dollar
The Euro continued to make gains against the Dollar yesterday, rising to a fresh four month high above 1.40, after a report in the Euro-zone showed that investor confidence rose to the highest level in over three-years. The single currency also made further gains versus the Pound, trading close to 1.16 in London, as money markets priced in a 25 basis point increase in European interest rates next month.
The single currency also traded close to a nine-month high against the Yen, before data this morning that is expected to show German factory orders rose in February, backing the case for the ECB to begin raising interest rates next month. Later today, the ECB will probably reiterate their willingness to raise interest rates as early as next month.
The Euro traded above $1.40 against the U.S Dollar exchange rate yesterday, but there was a strong area of resistance which triggered a number of stop-loss buying orders. The Euro-zone economic data showed that business confidence increased to the highest level in 30-months in February and the Euro was also resilient in the face of a big downgrade in Greece’s credit rating.
There were, however, also concerns about debt levels and sovereign ratings and many peripheral economies in the Euro-zone are still embroiled in a recession. An interest rate increase at this stage would tend to reinforce downward pressure on growth and intensify further debt write-downs. There has also been renewed evidence that funds are selling Euro-zone bonds, which would tend to undermine the Euro.
U.K 00:01 – BRC Retail Sales (February)
U.K 00:01 – RICS House Price Balance (February)
GER 11:00 – Industrial Orders (January)
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