Following on from last week, the Pound posted its biggest weekly drop in three months against the majors after banking stocks plummeted and reports showed that the UK economy contracted by more than preliminary estimates in the fourth quarter to suggest that the recession is worsening.
The UK currency slumped to the lowest level against the Dollar since 1985, while the Pound also fell below 1.0600 versus the Euro, after the economy suffered its biggest contraction since 1980 and the BoE governor Mervyn King said last week that policy makers may begin buying ‘toxic’ assets within weeks.
The UK economy has now shrank for two consecutive quarters, the technical definition of a recession, and Mervyn King also conceded that the most aggressive easing in UK interest rates in history has failed to stimulate economic growth and the Central Bank will now how to look at quantitative easing measures to revive sentiment.
The fiscal and monetary measures highlight the severe problems facing the government and the Pound dropped as much as 2.7% to $1.3503 against the Dollar on Friday, the lowest level since September 1985, and the UK currency lost 7% in value against its U.S counterpart over the course of the week.
The Pound also lost another 4.4% in value against the Euro, a trend that may continue towards the end of January, amid speculation that the Bank of England will cut interest rates by another 50 basis points in February as gross domestic product fell 1.5% in the fourth quarter.
In terms of economic data, the Pound’s depreciation was further enhanced as UK unemployment climbed to the highest level in nine years with the number of people out of work and claiming jobless benefits rising by 77,900 to 1.16 million, the highest level since January 2000, while home repossessions almost doubled.
The UK banking system was within hours of collapse on October 10th, just days before the government announced a major rescue package, according to an article from City Minister Paul Myners in the Times Newspaper.
Major depositors tried to withdraw from a number of large banks and were willing to pay penalties for early withdrawals such was the pessimism surrounding the banking sector and Myners comments will only serve to exacerbate the problem as shares in Barclays Bank Plc and the Royal Bank of Scotland Plc plummeted last week.
It will be interesting to gauge the Pound’s reaction to the comments this weekend, while Bank of England policy David Blanchflower also added to the pessimistic outlook for the Pound as he said the UK interest rates should “obviously” be cut to the near-zero level to aid the economic recovery.
The minutes from the Bank’s last policy-setting meeting in January showed that Blanchflower was the only member of the nine-strong monetary policy committee to vote for a bigger 100 basis point reduction as the economy continues to contract and unemployment is expected to rise to 3 million in the next year.
The Euro took advantage of broad Sterling weakness last week, while the single currency has remained surprisingly resilient versus the U.S Dollar amid speculation that the ECB will refrain from cutting rates in February and the Bundesbank President Axel Weber said that the German economy will recover in the second half of the year.
Weber is a member of the ECB governing council and has previously expressed reluctance to cut interest rates below the Central Bank’s 2.0% ceiling even as economic data points to a worsening recession but the government’s bank rescue package is expected to stimulate the economy going into 2010.
There is a plethora of survey data released for January this week, including the EC’s sentiment reports and the German Ifo index and the Euro may come under some pressure as all are expected to remain at near-record low levels, reiterating the weak tone of the flash PMI’s earlier in the month.
The rising appetite for risk aversion and the feel good factor from President Barack Obama’s inauguration last week has helped drive the Dollar and the Yen higher despite reports that the worst credit crisis since the Great Depression has pushed the U.S economy into a recession.
Gross domestic product contracted at a 5.5% annual rate from October through to December, the biggest decline since 1982, as consumers and businesses retrenched but Congress are working to pass an economic stimulus plan worth $825 billion by mid February that may actually curtail the Dollar’s momentum.
According to Citigroup Inc, the U.S currency will decline as commodities rally and signal that the Federal Reserve may succeed in reviving the economy from the worst post war slump by pumping an unprecedented amount of money in the financial system.
The focus this week will fall on the accompanying statement from the Fed policy announcement, while the first estimate of economic growth in the fourth quarter will be of equal importance in setting the tone for the week as the economy is forecast to record the worst performance since the early 1990s.
Data Released 26th January
U.K 00:01 Hometrack House Prices (January)
U.S 15:00 Existing Home Sales (December)
U.S 15:00 Leading Indicators (December)
written by Adam Solomon
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