The pound rose to its highest level against the Euro since 7 November 2008 as global stock markets fell sharply on renewed concerns over the European banking sector.
Investors are apprehensive ahead of a deadline this week for Euro zone banks to repay loans taken out a year ago at low interest rates.
As a result, leading stock markets were hit hard, with the UK’s FTSE 100 slipping 3.1%, France’s Cac 40 losing 3.6% and Germany’s Dax falling 3.1%.
The European Central Bank will offer funds on Wednesday to banks looking to repay 442bn Euros worth of loans later this week.
“Markets are tense going into the end of the long-term refinancing programme, along with Wednesday’s three-month auction,” said John Hydeskov, senior currency analyst at Danske.
Last summer, the ECB was forced to offer European banks cheap 12-month loans to help them through the financial crisis. This was a longer repayment term than the usual three to six months.
But the ECB has said it will not offer 12-month loans this time around, raising fears that European banks may again face funding difficulties.
So with heightened concerns about which banks still have bad loans on their books, there is a growing fear among investors about the health of the European banking sector.
The pound, in the short term, is benefiting from all this as fears among credit ratings agencies and investors about the UK’s burgeoning budget deficit have been allayed by last week’s Budget, in which the new coalition government announced stringent measures to cut spending and increase taxes to reduce debt levels.
The pound also benefited from recent comments made by Bank of England Monetary Policy Committee (MPC) member Andrew Sentance in which he said the UK would need to start raising interest rates soon.
Mr Sentance voted to raise rates at an MPC meeting earlier this month.
Analysts said that if inflation remains well above the Bank’s 2% target rate, the pressure to raise rates will increase.
Inflation, as measured by the Consumer Prices Index, currently stands at 3.4%.
“If inflation expectations show further signs of rising, and if nominal demand remains robust, we think the MPC will become increasingly uncomfortable with the current loose policy setting,” said Barclays Capital.
Higher interest rates make the pound a more attractive investment and tend, therefore, to increase its value.
In the short term, the pound may also gain as today’s scheduled publication of the final GDP figure for Q1 in the UK has been delayed for ‘technical reasons’ until 12 July. Some analysts had predicted earlier on this week that the provisional rate of 0.3% may be scaled back in the final figure undermining confidence in the UK economic recovery.
House prices in the UK rose again in June but only by 0.1%, according to the Nationwide building society.
The rise follows a 0.5% increase in May, with the average property in the UK now costing more than £170,000.
Prices have risen by 3% since the start of the year, the Nationwide’s house price index showed.
However, the rate of annual house price inflation fell again to 8.7%, with prices rising more slowly than they did this time last year.
Commenting on the figures, Nationwide’s chief economist Martin Gahbauer said the slowdown may be due to an increase in the number of properties up for sale.
The pound’s recent gains may however be short lived as UK banks must replace £800bn of funding by the end of 2012, at a rate of £25bn a month – more than double the £12bn monthly rate so far this year.
Some £285bn of the funding is emergency support provided during the crisis, which the industry wants extended but the Bank of England is adamant will not be.
In addition, cuts announced in the Budget could lead to up to 1.3 million jobs being lost by 2015, a newspaper report claims.
The Guardian says leaked Treasury figures predict that up to 120,000 public sector jobs and 140,000 private sector jobs could disappear annually for the next five years.
Labour figures said the true cost of George Osborne’s Budget was now clear.
But the government said independent experts expect “unemployment to fall in every year and employment to rise”.
The Guardian says the figures come from a slide which was part of a Treasury presentation on the Budget.
It claims the Chancellor would have seen the presentation before delivering his Budget last week.
A Treasury spokesman said last night that the department could not immediately confirm or deny whether the slide was genuine.
In response to the Guardian story, the Treasury cited a report by the independent Office for Budget Responsibility, set up by Mr Osborne, which predicts that unemployment will peak this year at 8.1% and then fall in each of the next four years to reach 6.1% in 2015.
GBP/USD
Poor US consumer confidence figures and fresh concerns over euro-zone fiscal problems ahead of massive bank repayments to the European Central Bank this week sent the Dow Jones sharply lower in New York to close 2.65% down and below 9,900 points.
The S&P 500 fell to within striking distance of its 2010 intraday low, which analysts said could trigger further declines. The index is on course to close at its lowest level since November — another bearish signal for markets.
The equity sell-off was broad and deep in a continuation of a wave of selling that started in Asia overnight and then moved into Europe. Economically sensitive sectors such as materials, industrials and financials bore the brunt of the selling.
U.S. consumer confidence dropped sharply in June, after rising for three months, on worries about the labour market, according to a report from the Conference Board. The news fed fears of an economic slowdown after recent weak data from the housing and job markets.
Fears about the strength of the banking system surfaced again, with investors worried about a potential liquidity shortfall of more than 100 billion Euros in the financial system as European banks repay 442 billion Euros ($545.5 billion) in emergency loans on Thursday.
Tom Forester, fund manager of the Forester Value Fund, said “People are now starting to figure out that growth is going to be a little slower than people had expected,” he said from Lake Forest, Illinois. “Stimulus goes flat, I think, next quarter and the inventory rebuild is over.”
As a result, the pound lost ground against the dollar, Japanese Yen and Swiss Franc, all seen as ’safe haven’ currencies in the markets.
GBP/High Yielding Currencies
In the US, the Conference Board corrected its leading economic index for China to an April gain of 0.3% from a previously reported rise of 1.7%, a sharp revision that undermined confidence in China’s ability to sustain strong growth.
The correction prompted investors to turn against riskier assets, adding to a global sell-off. The Shanghai composite index fell 4.3 percent to a new 14-month low.
“The hint of moderation is what alarmed markets as it comes in the context of fragile U.S. and European economies at the time we look to Asia as the global economic savior,” said Peter Boockvar, equity strategist at Miller Tabak + Co in New York.
The CBOE volatility index VIX, known as Wall Street’s fear gauge, rose 16% to a session high of 34.69, its highest level since early June.
The worldwide move to risk aversion also showed in the commodity markets with oil falling over 3% to under $76 a barrel but gold reaching a new high of $1245 per troy oz. This allowed the pound to reach multi month highs against the Australian Dollar and rise significantly against the New Zealand Dollar and South African Rand.
Sterling has rallied substantially against a basket of major currencies during trading this morning, trading up towards 1.2300 against the Euro and holding above the key $1.5000 support level against the U.S Dollar.
The dollar began the week on the defensive, after markets adopted a cautious approach over the outlook for the U.S economy.
Markets are becoming anxious ahead of the repayment of nearly half a trillion euros of one-year funds to the European Central Bank (ECB) which is due to occur later on this week. Much of the funding is anticipated to be rolled over by shorter term maturities – which should potentially leave a sufficient amount of liquidity in the system.
Markets are also closely watching for the outcome of debt auctions by France and Spain later in the week after demand for Italy’s sale of €7 billion of government bonds yesterday was described as ‘lukewarm’. Traders are also reluctant to place bets against the dollar ahead of Friday’s release of the U.S non-farm payrolls report for June.
This morning sees the release of the European Commission’s closely watched business climate and sentiment surveys for June. These reports could further underline concerns about the pace of economic recovery in the euro-zone, and are likely to weigh further on the euro.
Later in the day the attention will turn to the U.S where the Case Shiller House price index for April is due for release alongside consumer confidence for June.
The latest survey for the U.K housing market by Hometrack has confirmed that house prices in the United Kingdom are continuing to rise but the report also confirmed that the rate of appreciation appears to be cooling. The number of houses being put up for sale rose at a faster rate than the number of buyers, which could further limit price rises in the months ahead. The average property value in England and Wales is now £165,314, according the Land Registry’s figures.
EUR/USD
The euro has fallen back below the $1.23 level versus the U.S dollar, after a general spike in risk aversion created a fresh wave of selling on the back of funding concerns following a dip in Asian and U.S stocks.
European interbank rates hit their highest level in almost seven months yesterday as markets get anxious ahead of the repayment of nearly half a trillion euros of one year funds to the ECB later this week.
ADDITIONAL NEWS:
Following the G20 Summit in Toronto, which took place over the weekend – China has set the exchange rate for the Yuan at its highest level in five years, after previously saying it would make the currency more flexible. China has come under increasing international pressure to allow the Yuan to appreciate. The U.S have argued that the weak Yuan gives Chinese exporters an unfair competitive advantage. At the G20 meeting, Barack Obama expressed his hope again that China would allow the Yuan to rise over the next few months.
Data Released 29th June
FRA 07:45 – Consumer Confudence (June)
UK 09:30 – Consumer Credit – Mortgage Applications (May)
Following on from last week, Sterling has broken through the key $1.5000 resistance level against the U.S Dollar this morning, and is holding above the pivotal 1.2000 level against the Euro.
The dollar has begun the week on the defensive, as markets have adopted a cautious approach over the outlook for the U.S economy, following Friday’s release of Q1 GDP data.
The report confirmed that the U.S economy expanded less than expected during the first three months of 2010, with GDP growth revised down from 3.0% to 2.7%. The disappointing outcome of the report has raised concerns that the upturn in the U.S is too weak to reduce unemployment.
The G20 weekend brought nothing fresh to markets, with the group agreeing that countries would follow their own paths in terms of economic growth. There were pledges to attempt to halve budget deficits by 2013, without hitting growth too hard, as well as promises to clamp down on risky behaviour by banks.
Data released by the U.K overnight showed growth in house prices slowing marginally in June, although this still took the year-on-year rate to its highest level since January 2008. According to property data company Hometrack – prices rose an average 0.1% last month down from 0.2% in May but up 2.1% in annual terms. This report is likely to lend further support to the pound versus the euro, with sterling still underpinned by the positive reaction to last week’s U.K emergency budget.
There is no UK data of note today, However the housing market will be in focus this week with data from Nationwide due to be released on Wednesday. Final Q1 GDP data is also due to be released on Wednesday, with no changes to growth anticipated.
The U.S labour market is expected to be the main focus for this week, with Non-Farm Payrolls report for the month of June due to be released on Friday. The payroll rose by 431,000 in May (the largest monthly gain since early 2000) However, only 41,000 jobs were added over the month which was well below market expectations. A drop of 70,000 is anticipated this month.
ADP employment data, due to be released on Wednesday is expected to provide some advance indication of the overall outcome of the Non-Farm Payrolls report.
Additional data to watch this week for the U.S includes consumer confidence reports for June along with Manufacturing ISM data, construction spending and personal income/consumption figures.
In the Euro-Zone, the final Markit manufacturing PMI report for June is due to be released, and is anticipated to confirm the dip shown in the previous flash estimate. Business Activity and sentiment surveys are also expected to ease back – which would further underline concerns about the pace of recovery in the Euro-zone.
M3 data is anticipated to re-iterate the ongoing problems with credit conditions within the Euro-Zone, and Flash HICP data for the month of June is expected to show inflation well below the 2% target. These reports will be important in terms of setting the tone for markets/currency movements.
EUR/USD
The euro slid against the U.S. dollar this morning, after the leaders of the world’s largest economies agreed on a timetable for halving their budget deficits within three years.
EUR/USD hit 1.2355 during late Asian trade, shedding 0.12%, after pulling back from a 1-week high of 1.2397.
The world leaders reached the agreement at the G20 summit in Toronto on Sunday, in a signal of their determination to now stress debt reduction after enacting spending programs to counter the global financial crisis.
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.
The Pound made gains against the Euro during trading yesterday, rising back above the pivotal 1.2000 level. Sterling also rose impressively versus the U.S Dollar – rising towards the key 1.5000 resistance level during the afternoon and holding above $1.4800 by the close of trading last night.
The pound recovered some of the losses made during the last few days after the threat of the U.K losing its AAA credit rating receded following the emergency budget.
Minutes of the latest Bank of England policy meeting were released yesterday morning. The minutes confirmed that policy makers voted 7-1 to keep interest rates on hold for the 15th month in a row – One member of the Monetary Policy Committee, Andrew Sentence voted for an interest rate rise.
This was the first call for a U.K rate rise by an MPC member since August 2008, and has surprised economists, who expected another unanimous decision.
The Bank of England also decided not to inject any more money into the U.K economy under its policy of quantitative easing (QE).
Inflation hit a 17-month high of 3.7% in April, and even though it fell back to 3.4% during the month of May, the figure remains well above the Bank’s 2% target.
Mr Sentance argued that the persistence of inflation had cast doubt on the Bank’s prediction that spare capacity in the slow economy would be enough to bring inflation down. However, the other committee members felt that this argument was not enough to justify a change in policy.
Chancellor of the Exchequer, George Osborne has said that lenders need to share the pain of tax increases after he announced a levy on lenders’ balance sheets.
Osborne’s levy is designed to curb banks’ reliance on the short-term funding that helped trigger the biggest financial crisis since the Great Depression. France and Germany are also considering similar taxes as they try to tackle budget deficits swelled by bank bailouts and stimulus measures. France are scheduled to present a plan in its budget, and the German government are expected to publish legislation this summer,
In the Euro-Zone, reports have confirmed that business confidence in Belgium fell by more than economists had previously forecasted.
The confidence Index for Belgium (The sixth-largest economy in the Euro-Zone) declined to a 6-month low, pulled down by growing pessimism in the manufacturing industry. Business sentiment also declined in France, adding to signs that the recovery is slowing across Europe.
The dollar came under pressure overnight after the Federal Reserve announced a more cautious assessment of the U.S economy than in its previous statement. Interest rates in the U.S are expected to remain on hold for an ‘extended period’.
The Statement confirmed that recovery is continuing and noted that the labour market is improving gradually. However, underlying inflation has trended lower and “is likely to be subdued for sometime”.
Economic data released from the U.S yesterday afternoon confirmed that purchases of new homes fell in May to the lowest level on record after a tax credit expired – confirming that the market remains dependent on government support.
The Fed’s statement noted the continuing difficulties in the housing market as well as the constraints on household spending. The statement also suggested that the sovereign debt crisis in Europe has created financial conditions that are “less supportive of economic growth”.
EUR/USD
The prospect of U.S rates remaining close to zero for the foreseeable future yet is set to weigh on the dollar. The euro, however, is unlikely to take much comfort in prospects for the Euro-zone. Concerns about the fragility of economic recovery intensified following yesterday’s news of a dip in June’s closely watched PMI surveys.
The long awaited emergency budget has given sterling a noticeable boost as markets took comfort from the firm but measured response to the worst sovereign debt threat that has faced sterling for many years. Around 23% of the reduction on the deficit will be achieved through extra tax, most notable a VAT increase to 20% and an increase in capital gains tax from 18% to 28% for higher rate tax payers. That leaves 77% to be saved from public spending cuts which include a freeze on public sector pay and other cost cutting measures that will see up to 25% spending cuts across many departments. The market is now waiting for the reaction of ratings agencies, who are expected to affirm if not applaud the chancellor’s plans.
Sterling is accurately reflecting what everyone is feeling about this budget. It was probably necessary and could have been worse, and the general feeling is one of relief. For that reason the pound is now touching 18 month highs and looks to have positive momentum behind it. We remain optimistic of further gains in the short term. Buyers of the Euro should consider placing limit orders to capture any further upside movement. It would take a break below 1.1900 (Monday’s low) to cause concern.
The pound recovered some of the losses of the last few days as the threat of the UK losing its AAA credit rating receded following the emergency budget.
The six week old government announced a series of measures including the imposition of a levy on banks and raised VAT in the biggest budget-deficit cuts in a generation, seeking to guard the top credit rating without stifling economic recovery.
Lowering forecasts for growth to 1.2% this year and 2.3% in 2011, Chancellor of the Exchequer George Osborne announced a freeze on public workers’ pay and child benefit along with a reduction in housing benefits. Capital gains taxes were raised and corporate-profit taxes cut.
“This is the unavoidable budget,” Osborne told Parliament, delivering the package six weeks after taking over. “Everyone will be asked to contribute.”
Tackling the largest fiscal shortfall in the Group of 20 nations may test the durability of the Conservative-Liberal Democrat coalition and the strength of union opposition. It also leaves the UK at odds with President Barack Obama’s stimulus drive on the eve of the G20 meeting in Toronto.
Osborne, 39, the youngest chancellor since 1886, is aiming to cancel a deficit that reached 11% of GDP in the last fiscal year. Fitch Ratings warned on June 8 the U.K. may lose its AAA rating if it fails to speed cuts. It has since commented that yesterday’s budget was “a good start”.
The pound and gilts rose as Osborne announced the plan would eliminate the structural deficit by 2015, with net debt peaking at 70% of GDP by 2014. He rejected suggestions the government needed to choose between growth and fiscal order as a “false choice.”
Overall, he said spending would be cut by 30 billion pounds a year, including 11 billion pounds from welfare, while the increase in value-added tax to 20% in January from 17.5% would yield 13 billion pounds a year by the end of the Parliament in 2015.
The levy on banks would tax their balance sheets starting next year, generating 2 billion pounds of revenue. The tax will be set at 0.04% in 2011, before increasing to 0.07%. The levy will apply to British banks as well as the subsidiaries and branches of overseas banks. Firms will only be liable for the levy when their relevant aggregate liabilities exceed 20 billion pounds, the Treasury said on its website.
Pledging to bolster investment and employment, the government put the corporate tax on a slide to fall 4% to 24% over four years and raised the threshold at which employers start paying national insurance.
To blunt the impact of the cuts and convince voters that ordinary Britons won’t suffer unduly, Osborne raised the ceiling at which the lowest rate of income tax is levied by 1,000 pounds to 7,475 pounds, exempting 880,000 low earners from payment. He also maintained spending on schools, hospital buildings and other infrastructure projects. The basic state pension will now be linked to earnings rather than prices, he said.
“Unemployment will peak at 8.1% this year before falling to 6.1% in 2015″ Osborne said.
In increasing the tax cap, Osborne adopted a policy of the Liberal Democrats, junior partner in a coalition with Osborne’s Conservatives. The increase in VAT may still lead some Liberal Democrats to rebel as unions call for an emergency meeting to develop a strategy to fight.
Policy makers say a Greek-style bondholder revolt is a bigger risk to the economy than a return to recession and that restoring order to the public balances will ultimately boost the economy. Bank of England Governor Mervyn King last week backed retrenchment and said “monetary policy could respond if the prospects for growth subsequently deteriorated”.
“Some have suggested that there is a choice between dealing with our debts and going for growth,” Osborne said. “The crisis in the euro-zone shows that unless we deal with our debts there will be no growth.”
The argument over how soon to withdraw stimulus as the global recovery gains momentum will play out on the world stage when G-20 leaders convene in Toronto on June 26-27.
Obama said in a June 16 letter to his counterparts that they must avoid the “mistakes of the past” when economic support was withdrawn prematurely, while German Chancellor Angela Merkel says “there is no alternative” to cutting deficits. Japanese Prime Minister Naoto Kan’s government today vowed to cap annual spending for the next three years and balance its books in a decade.
“The U.K. is a test case,” said Tim Adams, a former U.S. Treasury undersecretary and now managing director of the Lindsey Group, a Fairfax, Virginia-based investment consulting company. “If Osborne’s budget works that will have a profound impact on the debate in the U.S.”
Meanwhile, Fitch, the ratings agency said that although the risk of a euro zone break-up was low over the short to medium term, further episodes of “extreme market volatility” were likely to persist until the recovery and deficit reduction were secured in the region.
A report by Fitch said the crisis in the euro zone and investor concerns over the sustainability of the region had arisen because of the existence of the following:
- Economic imbalances.
- Scepticism over the ability of economies within the euro zone to adjust in the absence of monetary and exchange rate flexibility.
- Concerns about fiscal solvency given large fiscal deficits and weak economic growth prospects.
- Doubts over the political commitment to the euro zone in the aftermath of the hesitant and reluctant support given to Greece.
The report came as Juergen Stark, executive member of the ECB, said that markets and ratings agencies had behaved irresponsibly in response to the debt problems faced by Greece.
“What we have seen, how markets have reacted on Greece, on other countries, and in particular rating agencies, this was done in an irresponsible way, an irresponsible way in the case of Greece,” he said at a Centre for European Reform event in London.
“In the middle of negotiations [with the International Monetary Fund], rating agencies downgraded Greece. Markets have exaggerated the problems,” he added.
Mr. Stark argued that the euro zone’s monetary policy framework did not need to change because of the sovereign debt crisis.
“What we are witnessing now is not a crisis of the euro, what we are witnessing is a loss of public confidence by markets in the ability of governments to run sound and responsible fiscal policies,” he said.
“Where I do not see any need for an adjustment or change is the monetary policy framework we are in. We need to step up fiscal consolidation and implement structural reforms. Secondly, we have to strengthen the fiscal rules. And thirdly, the economic policy co-ordination has to be enhanced, and the surveillance as well.”
Mr. Stark said he did not believe that enthusiasm for euro membership was waning among the German public. Germany was perceived to be reluctant when it came to committing to a €500bn (£417bn) fund facility for troubled countries in the region.
“They, the Germans, have [seen] that the euro is a stable and credible currency, and they appreciate that the ECB has delivered over the past 10 years,” Mr. Stark said.
The Euro zone was further undermined when the rating’s agency Moody’s downgraded the credit rating of one of France’s top banks, BNP Paribas.
Ahead of the publication this morning of the minutes of this month’s Bank of England Monetary Policy committee meeting, the pound continues to regain the losses of the last week to edge up towards the 20 month highs seen earlier this month. If, however, the minutes show that the MPC’s Quantitative Easing (QE) program is not over, this could once again undermine the pound.
Sterling / US Dollar
The pound also made inroads against the dollar following the release of poorer than expected housing data yesterday afternoon from the US.
Sales of previously owned homes fell unexpectedly in the US in May as delays in processing mortgage applications hampered the closing of contracts benefiting from a popular homebuyer tax credit, an industry group said on Tuesday.
The National Association of Realtors said sales fell 2.2% month over month to an annual rate of 5.66 million units from an upwardly revised 5.79 million-unit pace in April.
Analysts polled by Reuters expected May sales to rise 5.5% to a 6.12 million-unit pace from the previously reported 5.77 million units in April.
Sales were up 19.2% compared to May last year.
Sales had been expected to rise as transactions for existing homes are measured at contract closing. Although the tax credit for home buyers expired in April, qualified home owners have until June 30 to close contracts.
“There hasn’t been much of a rebound in housing. We are growing from the extremely low levels of last year. On average, we are looking for a moderate advancing trend,” said Stephen Stanley, chief Economist at Pierpont Securities in Stamford, Connecticut.
U.S. stock indexes pared gains on the report, Treasury debt prices rose.
The dollar was up slightly against the euro but fell to a session low against the pound.
The return to risk appetite following the Chinese action over the weekend to liberalize the Yuan against the US dollar appears to be short lived. The poor US data and persistent worries about the Euro zone have undermined confidence once again.
Falls were registered in virtually every stock market yesterday including London, Frankfurt, New York, Tokyo and Shanghai and oil prices also fell.
Tonight’s Federal Reserve Rate meeting is expected to be a ‘non event’ in light of the mixed data coming out of the US of late.
GBP/High Yielding Currencies
The pound recovered against the high yielding currencies yesterday as a combination of the UK emergency budget and China pulling back the veil on its new currency regime a little further on Tuesday, appearing to engineer a fall in the Yuan to make clear its vow of flexibility did not include one-way bets for appreciation helped the pound retrace against the Australian Dollar, New Zealand Dollar and South African Rand.
Big Chinese state-owned banks kept the Yuan in check, a day after its biggest rise since the currency was revalued in 2005, and the Foreign Ministry said change would be gradual, indicating the Yuan’s appreciation will be far slower than the pace demanded by critics in the West.
China has started to relax its control over the Yuan ahead of this weekend’s G20 summit of world leaders in Canada, breaking a two-year dollar peg that had been a lightning rod for critics who say the currency is undervalued and gives Chinese exporters an unfair trade advantage.
“China has backed up all the talk with action, and President Hu (Jintao) will arrive in Toronto later this week with tangible evidence that China is serious about increasing the flexibility of its exchange rate,” said Brian Jackson, strategist with Royal Bank of Canada in Hong Kong.
“We still may see moves in either direction from day to day, but we think the trend in the weeks and months ahead will be for the Yuan to make limited but meaningful gains against the dollar.”
Under its new freedom, the Yuan rose on Monday more than 0.4 percent, the biggest rise in a day since its landmark revaluation in 2005. It also came close to hitting its trading limit of 0.5 percent, an amount the currency can move either side of a reference point set each morning by the central bank.
On Tuesday, the Yuan fell just over 0.2 percent.
The fall disappointed many market players, who had initially thought the central bank’s decision to set the reference rate in line with Monday’s close was a sign that it was willing to let the currency strengthen further.
State-owned banks stepped in to the market by mid-morning and aggressively bought dollars, traders said, suggesting authorities want to control the pace of the Yuan’s appreciation.
The Pound continued to trade downwards yesterday ahead of today’s Emergency Budget.
Chancellor George Osborne will have to perform the difficult balancing act of showing that the UK means business about reducing its debt while not threatening the fragile economic recovery.
In the election campaign the Conservative party made no secret of its desire to slash public spending, though it was careful to be vague about where the axe would fall, and it will also have to bite the bullet and raise taxes. The expectation is that the ratio of cost savings to increased tax revenues will be about four to one.
Osborne toed the party line in a week-end TV interview by repeating the mantra of his leader that “we are all in this together” so it is likely that the tax burden will affect all parts of society, though perhaps the middle classes have the most to fear.
The government has already flagged its intention to hike capital gains tax (CGT) from its present level of 18% to 40% but it is probable that there will be numerous exemptions and taper relief clauses following grumbling from the Tory back benches.
Value Added Tax (VAT) could be increased from 17.5% to 20%, or the number of items which are exempt from VAT could be reduced, or the chancellor could do both of these things. Retailers moaned when the previous chancellor temporarily cut VAT to 15% in an attempt to keep the economy ticking over, and they moaned again when VAT went back up to 17.5% so soon after the busy Christmas trading period and ahead of the January sales, so there is a good chance that any increase in VAT will be delayed to give the retail trade time to adjust their prices.
The departed Labour administration was surprisingly macho about cutting the basic rate of income tax and the political world really will have turned on its head if a Conservative dominated government put up income tax. It is possible, however, given that a two point rise in the basic rate would still leave income tax lower than it was under the last Conservative government, plus they could lump the blame for it on to their Liberal Democrat partners.
More probably the chancellor will bump up the tax-free allowance, with the consensus view being that it will be raised to £10,000 from £6,475, a move that will be of greater benefit to those on low wages. Official forecasts will show George Osborne’s emergency Budget hitting growth and costing jobs in the short term, government sources said last night, but the austerity measures will also create a brighter climate for the economy by the end of the parliament.
In a tough Budget that seeks to over-achieve on plans to eliminate the deficit, Treasury ministers accept that the new and independent Office for Budget Responsibility will mark down the growth and jobs forecasts as government spending falls and taxes rise.
But insiders who have seen the forecasts said that because the OBR will assume this is just a temporary shortfall of growth, the effect will be to increase spare capacity in the economy, creating room for a faster growth forecast just before the next election.
On a quiet day for data, property website Rightmove reported that House price inflation eased in June, with asking prices up by 0.3% on average, down from a gain of 0.7% in May as a wave of new houses came onto the market.
The online agent estimates there was a 22% increase in sellers coming to the market in June following suspension of home information packs with a large chunk of these still unsold.
The annual rate of inflation picked up from 4.3% to 5%, but Rightmove expects this to ease back as conditions get tougher later in the year.
Sellers and tenants face tougher times as deficit reduction measures, such as rumoured CGT increases, disrupt the fragile housing recovery, it said.
Rightmove’s commercial director Miles Shipside added that a continued dearth of mortgage availability and a recent surge in sellers will also knock confidence.
“These factors are likely to put an end to this year’s recovery in house prices,” Shipside said.
In Brussels, European Central Bank President Jean-Claude Trichet said governments in breach of European Union fiscal rules could face tougher punishment including the withdrawal of voting rights.
“A wider spectrum of financial sanctions needs to be considered, along with non-financial and procedural sanctions, such as more stringent reporting requirements or even a limitation or suspension of voting rights,” Trichet told lawmakers in Brussels today. The ECB’s chief also said that governments could consider changing the euro’s founding treaty.
EU officials are devising new fiscal rules to prevent a repeat of the European sovereign debt crisis, which was sparked when Greece’s budget spiraled out of control and forced it to seek an EU-led bailout. European leaders plan to outline the strengthened enforcement system by October after hammering out a $929 billion rescue program last month.
Trichet said governments should explore every route that “the legislation of Europe permits” to toughen EU rules. Beyond that “we could reflect on changing the Treaty.” The last revision to the EU’s treaties, signed in Lisbon, took eight years to negotiate and ratify.
The ECB last week published a document ruling out expulsion from the euro region as the ultimate penalty “because the very existence of this option would put the viability of the common currency into question and would thus not be seen as credible.”
Sterling / US Dollar
The pound initially made gains against the dollar as risk appetite was back on the agenda following the weekend action by the People’s Bank of China thus reducing the safe haven status of the dollar.
The Chinese authorities allowed the renminbi to appreciate modestly on Monday in the first day of trading since the end of the near-two-year currency peg with the US dollar was announced.
The central bank left the reference rate for trading of the currency unchanged in the morning, but the renminbi strengthened and was up 0.43 per cent at one point. The currency is allowed to trade 0.5 per cent above or below the reference mid-point every day.
Had Beijing not wished the currency to appreciate by that much, it could have asked the People’s Bank of China to intervene in the market.
Chinese central bank announced the shift in policy in a statement on Saturday.
However, in a follow-up statement on Sunday, it stressed that a substantial appreciation in the currency was “not in China’s interests” and that the exchange rate would remain “basically stable”.
Beijing’s statements appear to be a delicate political compromise aimed at defusing the mounting international criticism of its exchange rate, especially in the US, while reflecting the lack of domestic support for a significantly stronger currency given the ongoing problems in Europe.
Even with the modest appreciation on Monday, many asset markets round the world rallied, in part because they interpreted the decision as a sign of Chinese confidence in the global economy but also because it considerably reduces the chance that the tensions surrounding the level of the renminbi will spiral into a global trade war.
To put things into perspective, China now exports every 6 hours what it did in the whole of 1978!
The morning optimism from the Chinese move soon gave way to renewed fears about the health of the European banking system after a senior official stated that European financial institutions face mounting funding difficulties.
World stock markets, which had started the day brightly soon declined with the North American and Far East markets breaking a nine day winning streak.
This increased the appeal of the dollar as a safe haven and the dollar made late gains against the pound, Euro and Yen which continue to this morning.
GBP/High Yielding Currencies
The Chinese move improved sentiment and thus risk appetite with the high yielding currencies, principally the Australian dollar; New Zealand Dollar and South African Rand making gains against both GBP and the Euro as commodity prices jumped on renewed hope that the worldwide economic recovery would continue.
With today’s budget in the UK likely to dampen the appeal of the pound, further gains, at least until the Federal Reserve rate meeting in the US on Wednesday evening (UK time), are in the offing.
Following on from last week, the pound has opened below 1.2000 against the Euro and is holding just above $1.4800 against the dollar.
The main focus this week for the U.K will fall on the Post Election emergency budget, which is due to be released tomorrow afternoon. Tough measures are anticipated as the new coalition government attempt to reduce the U.K Budget deficit.
Therefore, as we build up to possibly the most extensive public spending cuts since Margaret Thatcher’s reign, the Pound may continue to weaken, as the government attempts to plug the deficit – currently the highest among the Group of Seven nations.
Some guidelines have already been released in terms of spending cut-backs, meanwhile on the taxation front there has been speculation over an increase in capital gains and VAT.
Minutes of the previous Bank of England policy meeting are also due to be released this week, and whilst interest rates in the U.K have remained on hold, markets will be watching the minutes closely for any indication of future policy – especially in terms of inflation/future interest rate increases.
Recent reports have indicated that U.K inflation has accelerated above the government’s upper 3% limit and as the economy gathers momentum, speculation that policy makers are beginning to feel uncomfortable with interest rates at a record low of 0.5% has increased.
In the United States, in a light week of economic data, the focus will fall on the monthly Federal Reserve policy meeting which is due to take place on Wednesday. Interest rates in the U.S. are anticipated to remain on hold with little expectation of change to their current policy stance. Markets will however, closely scrutinise the post meeting statement for any subtle changes in wording and will watch closely to see if there are any references to the sovereign debt crisis in Europe – which has intensified substantially since their last policy meeting.
In the Euro-Zone, concerns over sovereign debt are likely to continue to dominate – even though market sentiment has shown slight signs of improvement over the past few days. Data due to be released from the Euro-Zone this week could pose a threat, with negative forecasts for closely-watched indices including German consumer confidence for July.
Central banks in Norway, Hungary and the Czech republic are also due to meet this week – all are expected to keep interest rates on hold.
EUR/USD
Stock markets rallied and risk sensitive currencies appreciated versus the USD overnight after China announced over the week-end that it will allow greater flexibility in its currency.
The move, seen as a step towards global rebalancing, has been welcomed by the U.S and Europe and is anticipated to help ease trade tensions, and reduce the need for further monetary tightening in China.
The euro hit one month highs of $1.2484 versus the USD this morning – moving the rate further away from the four year low of $1.1875
Crude oil prices rose 2% as the week’s trading got underway, reaching their highest level since early May after China’s announcement raised expectations of higher petroleum imports by the world’s second-largest oil user. However, despite the positive tone – China’s announcement is unlikely to result in anything more than a modest Yuan appreciation.
The Pound traded within a narrow downward range yesterday ahead of today’s Pubic Sector Borrowing Requirement figures and next week’s emergency budget.
The PSBR will almost certainly highlight the huge task facing the 6 week old coalition government in its attempts to reduce the gargantuan budget deficit and thus preserve the UK’s AAA credit rating.
After the overnight low’s seen immediately after Wednesday night’s Mansion House speech by Chancellor Osborne and Bank of England Governor Mervyn King, the pound steadied on the back of better than expected Retail Sales figures for May. The headline figures which include auto fuel sales rose + 0.6% month to month. After a particularly volatile first quarter, when retail sales fell by 2.2%, the performance for the second quarter of 2010 looks materially better.
Ahead of next week’s emergency budget, in a survey of markets, the Bank of England warned that widespread fear over the possible collapse of a sovereign debtor, including Greece and Portugal, had sparked a mass of bets on a 20 per cent fall in the FTSE 100.
The warning coincides with calculations from the Bank for International Settlements (BIS) showing that Britain has major exposure to the Irish and Spanish banking systems, which many fear could be at risk in the next round of the financial crisis.
The Bank of England used its Quarterly Bulletin to warn that markets were under increased strain following the International Monetary Fund and European Commission’s bail-out of Greece.
It said that investors had fled into safe haven assets, including Treasury bonds, gold and, to some surprise, UK government bonds.
However, it pointed out that the number of investors betting on a 20 per cent fall in the FTSE 100 index, based on their purchase of options connected to such a scenario, had risen from below 5 per cent to about 13 per cent in the past month alone.
Although this is below the 25 per cent level around the time of the Lehman implosion, the rate of increase is similar.
Share prices have been hit by the fears surrounding sovereign debt in recent weeks.
Some analysts fear problems surrounding government bonds could trigger a repeat of Lehman-style events.
The BIS used its own Quarterly Report to point out that, although the strain had worsened throughout the international banking system, banks’ balance sheets were slightly healthier than in the early stages of the subprime mortgage crisis that led to the Lehman collapse.
However, it also pointed out that various countries in the euro area were particularly exposed to each other – both in terms of sovereign and private debt. Banks headquartered in Britain had larger claims on Ireland ($230 billion, £158 billion) than banks based in any other country. Britain has a $150 billion (£103 billion) exposure to Spain.
Investor confidence has been further shaken by the decline in the fortunes of BP, responsible for £1 in every £6 of dividends paid in the UK which has seen over £58 billion wiped off its share value since mid April.
To cap a disastrous week for the company, following CEO Hayward’s 8 hour grilling by Congress yesterday in Washington, BP has now been warned by Russian President Mr. Medvedev. Mr. Medvedev stopped short of saying the disaster would prompt a review of Russia’s partnership with BP, but he said: “This is a wake-up call.”
Standard and Poor’s yesterday cut the company’s credit rating, and warned that further downgrades may follow.
BP’s cost to date are $1.8bn, including the cost of the spill response, containment, relief well drilling, grants to the Gulf states, claims paid, and federal costs. Repeated attempts to cap the leak have failed.
David Wilton, a Partner at restructuring firm BTG Mesirow, predicted BP’s liabilities could reach £63bn, but played down fears that the company could collapse, observing that the payments will be spread over a long period of time.
US politicians have shown no signs of letting up an onslaught against the company, following the lead set by Barack Obama who has compared the disaster to the 9/11 terrorist attacks.
In Congress, Mr. Hayward faced a barrage of criticism for failing to ignore warnings signs before the fatal rig explosion.
European Union leaders tried to calm the jittery money markets yesterday by promising to cut their countries’ bulging deficits and subject their banks to urgent “stress tests” to prevent another financial crisis.
An EU summit in Brussels agreed that 25 banks in Europe would undergo “stress tests” by national financial regulators by next month. They include four in Britain – HSBC, the Royal Bank of Scotland, Barclays and Lloyds – but those most at risk are likely to be smaller institutions in Spain and Germany.
Jose Manuel Barroso, the president of the European Commission, welcomed the decision to make the “stress tests” public. “This should reassure investors by either lifting unfounded suspicion or by dealing with the remaining problems that may exist,” he said. “If state intervention is needed, this will be examined in a timely manner under the Community rules.”
A further sign of market nerves of what may lie ahead is Gold reaching a new high of USD$1,252 per troy oz in heavy trading yesterday.
Sterling / US Dollar
The dollar took a hit after a rise in jobless claims, weaker-than-expected manufacturing data and a big drop in consumer prices on Thursday prompted investors to scale back expectations of a U.S. Federal Reserve interest rate hike.
The dollar index was at 85.57, down 0.1 percent after brushing a one-month low at 85.491. Technically, it looked vulnerable after it broke through support at 85.85, with the next key level seen in the 85.13 area, its May 21 low.
Sterling hit a one-month high against the dollar.
“A number of currency pairs are at a critical juncture near range highs,” analysts at RBC Capital Markets said in a note. “Will they respect the range, or will they see technical breakouts? In this regard, the key level to watch is the dollar index, which needs to hold above 85.00 to prevent a larger liquidation of stale longs.”
EUR/USD
The euro held at three-week highs on Friday, on track for its second successive week of gains, while the dollar appeared vulnerable to further losses after falling below a key chart level.
The dollar fell after a slew of below-forecast U.S. economic data, which helped push U.S. Treasuries yields to their lowest in a week.
The euro held gains near $1.24 as investors shed short positions after solid demand at Spanish government bond auctions the previous day, easing concerns about Spain’s debt-servicing abilities and boosting sentiment for riskier assets.
“Financial system concerns have eased, and some players are re-establishing carry trades, seeking higher-yielding assets,” said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ. The euro rose as far as $1.2414 on trading platform EBS. By 0733 GMT, it was up 0.1 percent at $1.2387.
The single currency has gained more than 2 percent so far this week, pulling further away from a four-year low of $1.1876 struck on June 7.
“The euro remains upside corrective and on track to test the $1.2445 2009 low and inter-year pivot,” technical analysts at Commerzbank said. “This together with the 38.2 percent retracement of the move down from April represents our initial corrective target.”
European leaders agreed on Thursday to publish details of stress tests showing the financial health of individual banks next month and to toughen budget rules to restore confidence in their currency union.
Some in the market said the release of stress tests would boost investor trust in European banks but others were concerned they could reveal fragility in the sector and hurt the euro.
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