by Adam Solomon
Sterling / Euro and US Dollar
Following on from last week, the Pound declined against the Dollar for three straight days last week, while the UK currency lost ground against 15 out of the 16 most actively traded currencies, adding to declines from the previous week. Sterling is approaching its weakest level against the U.S Dollar in 10 months, after a report showed UK manufacturing unexpectedly contracted in January.
The report from the Office of National Statistics showed that factory output fell for the first time in five months, indicating that the sector is struggling to expand following the longest recession on record. Output was down 0.9% from the previous month, despite initial estimates of 0.2% expansion, and the Pound subsequently fell as much as 0.4% against the Dollar to a low of $1.4875.
The Prime Minister Gordon Brown has warned that the nation’s recovery will be far from smooth of the coming months but vowed that “we will weather the storm together.” Bank of England officials last week decided to keep the £200 billion bond-purchasing program on hold for a second month, as they assess the strength of the recovery.
BoE member Kate Barker also said last week that the UK faces a “bumpy” recovery and manufacturers haven’t yet benefited from the drop in the value of the Pound. Sterling has fallen roughly 25% in the past three years on a trade weighted basis but the latest trade balance shows that the deficit is widening with exports down 6.9%.
Policy makers are divided on whether additional stimulus may be necessary to cement the recovery and prevent a relapse. David Tinsley, an economist at National Australia Bank and a former MPC official, said that “until the recovery in the Euro-zone gets more entrenched, the outlook for manufacturing is going to be fairly heavy weather. It’s possible UK gross domestic product will be weak or a bit negative in the first quarter.”
The Pound has failed to break back above the key resistance levels at 1.10 versus the Euro and 1.50 against the U.S Dollar, indicating that a move lower is increasingly likely. The UK currency declined heavily on Tuesday, after Fitch Ratings said that Britain is taking too long to cut its budget deficit and may be susceptible to a downgrade in its credit rating from top level status.
Concern over the UK elections have also weighed heavily on Sterling, amid speculation that Britain may have its first minority government since 1974. A hung parliament would make it extremely difficult for officials to cut the ever-widening budget deficit, currently above 12% of gross domestic product.
Jeremy Stretch, a senior currency strategist at Rabobank International, said that “sterling remains weak amid ongoing concerns over debt ratings and political dynamics.” Concerns that Britain, which lagged well behind the U.S and the Euro-region in exiting the recession, will struggle to rein in its debt has made the Pound the worst performer this year among the 16-most actively traded currencies.
The National Institute for Social and Economic Research estimated that UK gross domestic product rose 0.3% in the three months to February, following a revised 0.6% increase the previous month. The data should maintain expectations that the economy is recovering, but doubts over the strength of the recovery are likely to remain.
The Pound staged a modest recovery against the majors on Friday, rising for the first time in three days against the Dollar and the Euro, after the Bank of England said that UK inflation expectations reached the highest level since November 2008. Sterling reversed an earlier decline, strengthening against all of the 16 most actively traded currencies, amid speculation of a near-term interest rate rise.
In reality, the governor of the Bank of England and a number of economists have said that inflationary pressures will subside later in the year and drop below the 2% target in 2011. Therefore, the prospect of a near-term increase in borrowing costs is unlikely, especially since the UK economy just about limped out of the recession in the fourth quarter.
The Bank’s quarterly survey, however, shows that UK consumers expect the inflation rate to hit 2.5% in a year’s time, compared with 2.4% in November. Stuart Bennett, a senior foreign exchange strategist at Credit Agricole Corporate and Investment Bank, said that “if inflation expectations are creeping up, this may be a catalyst for the market to give sterling a reprieve.”
The Pound edged above the pivotal $1.50 level against the Dollar and tested resistance at 1.10 versus the Euro but analysts are pessimistic on the chances of a recovery. Ian Stannard, a senior currency strategist at BNP Paribas SA, said that “the inflation expectations show a slight nudge higher. I’d suggest there’s not too much there for sterling to sustain the recovery. A move higher toward the $1.51 area should provide another selling opportunity.”
The Bank of England’s chief economist Spencer Dale said on Friday that a pause in quantitative easing did not mean that it had come to an end and there is likely to be further speculation that there could be an expansion of the bond-purchasing program within the next few months. Sterling has dipped lower against the majors this morning following a warning from Standard & Poor’s that the UK has moved closer towards a credit-rating downgrade.
There is a packed schedule of UK economic data released this week, with the focus falling on Wednesday’s release of the minutes from the last BoE policy meeting. Although policy makers left interest rates at a record low, investors will be watching the tone and language used in the minutes, given recent indications that the BoE is ready to act if the need arises.
Euro / US Dollar
The Euro rose against most of the major currencies towards the end of last week, rising 0.2% against the Dollar, as German bonds dropped to the lowest level in more than two weeks, amid renewed hope that Greece’s budget deficit will be reined in. Camilla Sutton, a Bank of Nova Scotia currency strategist, said that “there’s been a lot of stabilisation in Greece. Every day we’re moving slowly higher. That’s a good sign for the Euro generally.”
Concern within the Euro-zone has eased slightly, although there is still a high degree of caution, especially with strikes within Greece maintaining underlying fears over the budget outlook. The French President Sarkozy toned down his rhetoric against a weak Euro and this also provided a degree of support for the single currency.
Risk appetite was generally firmer during Friday, which also provided a degree of support to the Euro. The latest Euro-zone industrial production data was also stronger than expected, with an annual increase for the first time since 2008. The ECB President Trichet made comments on Friday that Greece had taken courageous and convincing measures on the budget deficit. His remarks suggest that the ECB has decided to provide strong verbal support to Greece.
U.S Federal Reserve policy comes into focus this week with the latest FOMC rate announcement due to be held on Tuesday, March 16th. There have been a number of diverging comments from policy makers expressing unease about interest rates remaining at record low levels for an extended period. A change in the tone or language of the accompanying statement would tend to support the Dollar, amid speculation of an interest rate increase.
Data Released 15th March
U.K 00:01 – Rightmove House Prices (March)
EU 10:00 – Employment (Q4)
U.S 12:30 – Empire State – NY Fed Index (March)
U.S 13:00 – TICS Capital Inflows (January)
U.S 13:15 – Industrial Production (February) – Capacity Utilisation
U.S 17:00 – NAHB – House Builders Sentiment (March)
Related posts:
- FX118 Foreign Exchange Daily Insight – The Pound rallies against the Dollar, as risk appetite improves
- The Dollar continues to depreciate ahead of the FOMC Rate Announcement
- The Pound rises above $1.6500 against the Dollar, ahead of the FOMC rate announcement
- FX144 Foreign Exchange Daily Insight – The Pound rallies against the Dollar, as risk appetite increases
- The Dollar makes further losses against the majors ahead fo the FOMC rate announcement
