GBPEUR/GBPUSD
The Pound rallied against the Dollar and the Euro yesterday, amid speculation that the UK currency’s decline on Friday was exaggerated, given the prospects for an economic recovery. The Pound rebounded from a low of $1.6254 against the U.S Dollar, after earlier extending its drop of 1.9%, the biggest decline since March 9th.
Economist at Goldman Sachs Group Inc Ben Broadbent and Kevin Daly said that last week’s report from the Office of National Statistics, showing that the economy unexpectedly shrank in the third quarter, may be “revised significantly higher in time.” The Pound is currently trading at the weakest level against the Euro in a decade and is making UK products less expensive and turning Goldman Sachs Group inc into Sterling bulls.
Purchasing power parity, a measure of the relative cost of goods, shows that the UK currency is 22% below where it should be. Sterling hasn’t been so cheap since 1999, after the Bank of England flooded the economy this year with £175 billion buying government and corporate bonds. The move was intended to keep borrowing costs from rising, as the economy shrinks, and policy makers may well increase that amount in the November 5th meeting.
UK assets have been dramatically discounted, as the seizure in global credit markets drove the economy into its worst recession since the Second World War. The government was forced to take stakes in two of the country’s biggest banks, to save them from bankruptcy and the Labour Party currently trails the Conservatives by 17 percentage points.
The government report last week showed that UK gross domestic product surprisingly shrank 0.4% in the three months through September, continuing the longest contraction of six consecutive quarters, since records began in 1955. Nevertheless, the Pound rallied 0.4% against the Dollar yesterday to a high of 1.6670 in London and 1% versus the Euro, as concerns grow over the impact of a strong Euro on exports in the region.
The Pound may struggle to hold on to yesterday’s gains, as speculation mounts that the Bank of England will extend the quantitative easing program in November and pump more money into the economy to revive growth. The Pound’s slide is fueling mergers and acquisitions in the UK, bringing the first net inflows to the country in three years. The last time that happened in 2006, the Pound jumped 2.1% versus the Euro and 13% against the Dollar, the biggest gain in 16-years.
Goldman Sachs predicted this month that Sterling will appreciate 9% versus the Euro to 1.1905 and by 14% to $1.85 against the Dollar, even as UK debt quintuples as a percentage of gross domestic product. According to Deutshce Bank AG, investors underestimate the risk that the BoE will increase interest rates from the current record low of 0.5%.
According to study by analysts on the Taylor Rule, an economics equation for predicting central bank moves based on policy makers’ tolerance for inflation and unemployment, rates should be about 2.75 percentage points higher than the current level. However, futures contracts predict less than a quarter percent increase by April 2010, the biggest disparity among the Group of 10 economies.
Henrik Gullberg, a strategist at Deutsche Bank, said that “the Bank of England is the most out of line among the G-10 nation in terms of policy.” The rate is likely to rise to 1.25% by the end of 2010, with increases starting in the second quarter. The ECB and the Federal Reserve probably won’t alter borrowing costs until at least the third quarter.
Elsewhere yesterday, the Pound also received a boost as UK business confidence rose to the highest level in 18-months. According to a report from KPMG, nineteen percent of executives say that the outlook for business is “good” or “very good”, up from 9% in the previous quarter. Consumer prices are also poised to rise faster than any other developed economy, as the inflation rate holds steady at 2.1% this year.
The Pound fell 4.4% against the Dollar in August and September, the largest two month decline this year, amid suggestions that the Bank of England favour a weaker currency and expanding the asset purchase program. The UK currency also lost 6.9% against the Euro, prompting Citigroup Inc and BNP Paribas SA to predict Sterling would reach parity with the Euro by the first quarter of 2010.
The UK budget deficit will swell to £175 billion in the year ending March 2010, roughly 12.4% of gross domestic product, the highest amongst the Group of 20 nations. The deficit was 77.3 billion in the first six months of the year, the largest for any half year period since records began in 1946. Peter Lucas, an investment strategist at RBC Wealth Management, said that “there might be scope for the Pound to rise in the near-term, but these underlying issues do require the Pound to be an undervalued currency for some time.”
A number of influential economists are seemingly turning bullish on Sterling with Goldman Sachs and JP Morgan Chase & Co advising clients to buy the Pound, as the market looks too bearish on the UK economy and way too short on Sterling. Barclays also predicts that the Pound will rise about 8% to $1.76 in March and 1.1764 versus the Euro.
EUR/USD
The Dollar advanced against the Euro yesterday, reversing a drop to the lowest level in 14-months, amid speculation that the Dollar’s decline beyond $1.50 will be difficult to sustain. The U.S currency also rose against a basket of currencies on bets that a drop in stocks would discourage investors from purchasing higher-yielding assets.
Vassili Serebriakov, a currency strategist at Wells Fargo & Co in New York, said that “at some point, the Euro will fall victim to its own success. We’ve seen the Euro touching new highs but really struggling to extend them significantly.” The Dollar advanced 0.7% to $1.4905 against the Euro, from $1.5008 at the close of trading on Friday.
The Dollar is also being buoyed by speculation that the Federal Reserve will divert away from ultra-loose policy and begin to tighten interest rates. Officials in the U.S are contemplating the best way to let the market know that a period of record low interest rates will draw to an end. The issue may be on the table when the FOMC meets in early November.
Data Released 27th October
U.K 11:00 CBI Distributive Trade Balance (October)
EU 09:00 M3 / 3 Month Moving Average (September)
U.S 13:00 Case Shiller House Prices (August)
U.S 14:00 Consumer Confidence (October)
written by Adam Solomon
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