Pound makes strong gains against the euro

The pound strengthened considerably against the euro yesterday as a strong performance on London equity markets improved investor sentiment that the UK may be close to an economic recovery. Easing concerns over the threat of swine flu and rising oil prices helped the FTSE 100 to hit a four-month high yesterday, finishing up 93.7 points. With the UK economy so dependent on the financial services and banking sector, the index’s strong performance yesterday drove demand for sterling against the single currency, as investor confidence that the recession may be bottoming out improved.

The pound also strengthened against the euro yesterday after forecasts released by the European Commission on Monday revealed a deepening recession in the eurozone. The commission’s report predicted the region’s economy would shrink by 4% this year, more than double the contraction projected in January, and 0.1% in 2010. It also said it expected the region’s inflation to average out at 0.4% this year, the lowest since the currency’s introduction ten years ago. Whilst it therefore seems increasingly likely the ECB will cut its interest rates to a record low of 1% tomorrow, President Jean-Claude Trichet has been tight-lipped in recent weeks over what other measures the central bank could take to stem the recession. Adding to the uncertainty, ECB Council member Athanasios Orphanides said yesterday that the financial crisis needs “drastic” measures, adding he would not rule out cutting the key interest rate to below 1% and embarking on a quantitative easing program similar to that employed by the US Fed and Bank of England earlier this year. Speculation surrounding what measures the ECB intends to introduce when it announces its decision tomorrow weighed on investors’ minds, and they therefore opted to buy into sterling instead. Interestingly, in contrast to the uncertainty surrounding the ECB’s interest rate decision tomorrow, investors are relatively relaxed about the Bank of England’s monetary policy meeting tomorrow, where most analysts expect it to follow the US Fed’s lead last week and simply keep everything on hold. As a result, sterling finished the day up against the euro at 1.1314.

In early trading today, the pound has pared some of yesterday’s gains as investor wariness ahead of the two big interest rate decisions continues. There are no major announcements due in the UK today, whilst in the eurozone Month-on-Month and Year-on-Year Retail Sales figures are due at 10.00 BST.