The Pound declined against the majors on Friday, as UK GDP contracted by more than twice as much as initial forecats


By on July 27th, 2009.
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GBPEUR/GBPUSD

Following on from last week, the Pound traded close to the highest level this month against the Dollar, touching a high of $1.6580 on Thursday, as improvements in retail sales and mortgage approvals prompted speculation that the recession is abating and the Bank of England will increase interest rates. The UK currency also rose for a second day against the Euro and the Japanese Yen, as a report from the Office of National Statistics showed that sales increased last month at four times the pace expected.

Tentative signs of improvement in the UK economy and store discounts encouraged consumers to step up spending, as sales climbed 1.2% from May, when they plunged 0.9%. Prior to the report, economists had predicted a smaller 0.3% increase and subsequently rallied against the majority of the 16-most actively traded currencies.

The rising unemployment rate still remains a major concern to consumers and that may keep a lid on spending in the medium-term. Bean also said this week that unemployment will probably keep increasing. The number of people out of work rose to 2.38 million in the quarter through May and the British Chamber of Commerce said this month that unemployment may reach 3.2 million by the middle of next year.

There was also an increase in BBA mortgage approvals according to the latest data with approvals at a 15 month high and this helped maintain the mood of greater confidence towards the UK housing sector, which also underpinned risk appetite. Loan approvals for home purchases increased to 35,235, from 31,919 in May and that level has almost doubled in seven months.

The Bank of England may raise UK interest rates as the first step towards exiting its quantitative-easing program. David Bloom, a currency strategist at HSBC Holdings Plc, said yesterday that “we find the idea that the UK will raise rates next year but the U.S will stand pat a very powerful one. This should be just the event to see the Pound gain.”

HSBC Holdings Plc raised its Pound-Dollar forecast for the end of 2010, citing the likelihood that the Bank of England will interrupt its asset-buying program next month and raise interest rates before the Federal Reserve. The Pound will climb to $1.75 by the end of next year, despite previous forecasts that the Pound’s “fair value” against the Dollar through 2010 was $1.60.

The UK currency has climbed 14% against the Dollar this year, after depreciating 26% in 2008, amid speculation that the worst of the recession is over. The Bank of England’s benchmark interest rate will rise to 1.25% by the end of 2010, from a record low of 0.5% currently. Bloom also stated that “the Pound’s longer-term fortunes are looking brighter, especially since the BoE’s quantitative-easing program is expected to take a clear breather soon.”

The Pound is still being driven to a large extent by trends in risk appetite and firmer equity markets continued to offer significant support yesterday. UK stocks climbed for an unprecedented ninth day on Thursday, the longest stretch of gains since 2004. The FTSE 100 Index gained 1.1% in London, while the Dow topped at 9,000 for the first time since January.

The Pound was unable to hold on to its recent gains on Friday, as the UK currency fell by the most in a month against the Euro, following reports that the UK economy shrank by more than twice as much as preliminary forecasts.The Pound also fell considerably versus the U.S Dollar, paring a second consecutive weekly advance, after the Office of National Statistics said gross domestic product contracted 0.8% in the first quarter.

The UK economy was expected to shrink just 0.3% in the three months through June, as a record annual slump in construction, banking and business services kept Britain entrenched in the worst recession for a generation. From a year earlier, the economy contracted 5.6%, the most since records began in 1955.

Bank of England policy maker Andrew Sentence said last week that the UK economy may start to pick up in the second half of 2009 but Gordon Brown’s Labour Party trails the Conservatives in the polls, less than a year before the general election. George Buckley, chief UK economist at Deutsche Bank AG, said that “it’s a very sizeable recession indeed. I think we’ve seen the worst, but what will the post-recession environment look like? There is a risk in the medium term that growth will be weaker than we’re used to.”

The Pound dropped as much as 0.5% against the Dollar following the report and Friday’s data is the first among the Group of Seven nations for the second quarter. The International Monetary Fund predicts that the UK will contract 4.2% this year, compared with 4.8% in the Euro-zone and 2.6% in the U.S. Lee Hardman, a foreign exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd, said that “the numbers were disappointing, they suggest that the economy is still on an unstable footing and that hit the Pound.”

The Bank of England said on March 5th that it would begin purchasing bonds as part of a so called quantitative easing policy, designed to lower borrowing costs and revive the economy. Policy makers pledged to buy £125 billion of assets, after getting permission from the Treasury to purchase £150 billion.

Andrew Sentence gave an indication last week that the bank will make a judgment call on whether they need to add further fiscal stimulus, once the new quarterly predictions are available. Jason Simpson, a UK interest rate strategist at Royal Bank of Scotland Group Plc, said that “what Sentence said hints to the fact that quantitative easing might be coming to a pause. We’ve also seen a risk rally with equities pushing higher, and that’s a challenge for bond markets.”

The Pound dipped to lows below $1.64 against the Dollar on Friday, but the underlying improvement in global risk appetite helped prevent further losses. Hometrack reported that UK house prices were steady during July, which helped maintain some degree of optimism over trends and also offered Sterling protection with the Pound back above $1.64 this morning.

EUR/USD

The Euro advanced to a near seven week high against the Dollar on Friday, amid reports that the contraction in European manufacturing and services industries slowed by more than initial forecasts. German business confidence also rose and the Euro subsequently posed a second weekly gain versus the lower-yielding currencies.

The single currency also rallied by the most in a week against the Pound, as signs of an improvement in the European economy indicated that the global recession is reaching a bottom. The currency market is still closely correlated with the broad swing in risk sentiment and the Euro is likely to rally further providing equity markets continue to improve.

The Dollar also declined on Friday after the revised University of Michigan consumer confidence data recorded a slight increase from the provisional figure. The data did not have a significant impact on the market and the U.S currency strengthened to beyond $1.42 versus the Euro. Investors will be monitoring official comments on the Dollar closely this week, with U.S Treasury Secretary Timothy Geithner due to gold meetings with Chinese Officials.

Data Released 27th July

U.K 00:01 Hometrack House Prices (July)

EU 09:00 M3 / 3 Month Moving Average (June)

U.S 15:00 New Home Sales (June)

written by Adam Solomon

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