Sterling / Euro
The pound hit a 19-month high on Thursday morning as debt woes weighed down on the euro.
The pound reached its highest point since the immediate aftermath of the financial crisis in November 2008.
Markets continue to worry about the European debt crisis, with the perceived risk of a default by Greece hitting an all time high.
The pound was also boosted by disagreement at the Bank of England about whether to raise interest rates.
At the Bank’s latest monetary policy committee meeting, Andrew Sentance broke with colleagues, including governor Mervyn King, to vote in favour of a rate rise.
This raised market expectations of future rate rises, making the pound a more attractive investment.
The pound has rallied nearly 20% since reaching a low of 1.02 Euros in December 2008.
However, it still remains well below the 1.50 level that it traded around in the years prior to the 2007 credit crunch.
The pound’s revival is mainly down to the euro’s fall from grace, and it is notable that the pound has not enjoyed a similar rally against the US dollar.
Markets are fearful over a European debt crisis that is already engulfing Mediterranean governments, and risks triggering a full-blown banking crisis across the continent.
The cost of buying protection against a default by the Greek government has hit an all-time high of 10% a year.
The euro has fallen 18.8% against the US dollar since the crisis began in January 2010.
With over 70% of the UK’s trade tied up with the euro zone, some analysts are suggesting that the pound is fast reaching a high point against the Euro and only a sustained economic recovery could push it higher.
Another factor worrying analysts in the medium term is any political instability in the UK that may arise if public reaction to the measures contained in Tuesday’s budget is negative. The Liberal Democrats could be particularly affected as they opposed a number of measures introduced in the emergency budget during May’s election campaign.
The stability or otherwise of the pound’s recovery against the Euro was again highlighted when it then fell over a cent in the afternoon after the publication of a report by the Bank of England showing that the economic recovery in the UK could be undermined by the UK banks if they struggle to refinance between 750 and 800 billion pounds of capital by the end of 2012.
Banks have been under heavy pressure to reduce staff bonuses as they attempt to rebuild their financial strength after the credit crunch, but the Bank of England still believes they have to do more to “sustain lending to the real economy”.
In its twice yearly update, the Bank said reducing bonuses to pre-crash levels and freezing dividends would both strengthen the banks’ balance sheets and enable them boost lending to business and other customers.
“This would require banks to double their efforts to contain discretionary distributions to shareholders and staff,” the Bank said in the report “The benefits of more concerted action are potentially considerable.” For every £10bn saved, it said, “around £50bn of new UK lending could be sustained”.
This refinancing also comes against the uncertainly of new rules on capital and liquidity to be introduced in the autumn. Action on bonuses and dividends would “help offset any reduction in lending that could otherwise be necessary if banks are to meet the funding challenges,” the Bank added.
Confidence is in short supply in the markets as policy makers still appear to disagree as to how best to manage the economic recovery.
As German chancellor Angela Merkel prepares to take her austerity message to the G20 in Toronto this weekend, the head of the European Central Bank Jean-Claude Trichet has held her up as an example to the rest of the euro zone.
“Merkel’s actions will boost confidence among households, investors and companies and will help consolidate the recovery”, Trichet said in an interview with Italy’s La Repubblica.
That view is at odds with what George Soros said Wednesday, when the legendary investor told an audience in Berlin that “the euro is a flawed construct”.
“By insisting on pro-cyclical policies, Germany is endangering the European Union,” Soros warned. “I realize that this is a grave accusation, but I am afraid it is justified.”
Trichet dismissed this, saying the euro was a very credible currency that has kept its value from its debut and has guaranteed price stability for nearly 12 years, with an annual average inflation of 1.98% in the euro zone in that period.
“A currency that guarantees such stable prices, is of value in the eyes of domestic and international investors” Trichet told the Italian paper.
The single European currency has fallen against the dollar since worries over certain euro zone countries’ ability to pay their debt begun.
On Wednesday, Soros said that “by cutting its budget deficit and resisting a rise in wages to compensate for the decline in the purchasing power of the euro, Germany is actually making it more difficult for the other countries to regain competitiveness.”
Merkel defended her actions over the weekend, saying they will prevent future crises.
But Trichet does not believe that austerity measures being put in place by European governments will cause deflation.
Some of the more bearish investors are betting that cuts in government spending across the European Union will add to deflationary pressures at a time when consumers and businesses are de-leveraging.
“Growth will fall sharply, with private sector deflation pushing yields on 10-year bonds down to 2 percent, triggering a new wave of quantitative easing” Bob Janjuah, chief markets strategist at RBS told CNBC earlier this month
Sterling / Euro
Stocks fell throughout Europe and in the US on Thursday, with bank shares under severe pressure in New York as negotiations over a financial reform bill approached the final hours, while investors remained skittish about the pace of the economic recovery.
Democrats in charge of the process appeared likely to retain tough restrictions on banks’ trading and investment activities that could crimp profits. JPMorgan Chase & Co was the biggest drag on the Dow.
A drop in initial jobless claims and a rise in long-lasting manufactured goods provided some comfort, but the reports were not enough to offset jitters after recent weak economic news, including Wednesday’s sharp decline in new home sales. The Federal Reserve’s gloomier statement about the economy underscored concerns.
“What’s on everyone’s mind is a potential double dip,” said Ryan Detrick, senior technical strategist at Schaeffer’s Investment Research in Cincinnati, Ohio.
“There’s still uncertainty in the financial reform bill … Until that’s resolved and we have a more clear-cut idea of what’s going to happen, that uncertainty will probably lead to continued relative weakness.”
In a bearish technical sign, the S&P opened below its 14-day moving average and breached a key level as it punched through 1,083, the 23.6 percent Fibonacci retracement of the slide from its 2010 high in April to the year’s low earlier this month.
GBP/High Yielding Currencies
Mining companies in Australia have expressed hope of reopening discussions about a controversial mining tax with the country’s new prime minister.
Julia Gillard, who has been sworn in as Australia’s first female premier, said she was “throwing open the government’s door to the mining industry”.
Her predecessor, Kevin Rudd, had slumped in the polls after proposing a 40% tax on mining profits from 2012.
Mining giant BHP Billiton said it was “encouraged” by Ms Gillard’s comments.
“The industry has consistently been calling for the government to take the time to properly engage on all aspects of the tax, and we welcome the opportunity to do so,” BHP said.
“We look forward to working with the government in this new way to find a solution that is in the national interest.”
Mining shares in Australia closed higher, with BHP rising 1.3% and Rio Tinto up 1.7%.
However, miners were the biggest fallers in London trading, after the US Federal Reserve said the US economic recovery was faltering, sparking fears over demand.
Data Released 25th June
JPN 00:30 – Core CPI (May)
FRA 07:45 – GDP Q1 (revised)
US 13:30 – Final GDP (Q1)
US 14:55 – Michigan Sentiment (June)
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