Merkel and Sarkozy offer little action
Last week’s meeting between Merkel and Sarkozy failed to provide any concrete action on the eurozone debt issue. The introduction of a eurozone bond was discarded as an option and the EFSF is not to be expanded. Vague commitments to common governance and a Tobin tax were the main results, neither of which inspired much confidence.
The euro is still trading fairly strongly tough, particularly against the dollar. This is largely attributable to increasing dollar-weakness and a degree of relief that the ECB are buying eurozone debt to stabilise peripheral bond yields.
US recession looms
The Philly Fed manufacturing index revealed an alarming contraction last week, intensifying speculation that the US economy is heading back into recession. The index gave its worst reading since the recession levels of March 2009. Global stocks suffered a major slide as a result, and riskier commodity-linked currencies sold off sharply, but the euro remains stable.
The US GDP figure is expected to be revised down by 0.2% to 1.1% (annualised) on Friday. Also on Friday is the key focus of the week, Fed Chairman Ben Bernanke’s speech. The prospects of a third programme of quantitative easing are improving with every poor piece of US data and Bernanke’s comments this week could be crucial for the dollar’s longer-term direction.
Sterling gains some safe-haven status
News from the UK economy was by no means positive last week. The monthly UK retail sales figure came in below expectations and UK unemployment data was particularly poor. In addition, the MPC minutes were very dovish indeed. The two remaining MPC hawks, Charles Bean and Spencer Dale abandoned their quest for higher UK interest rates and joined the rest of the 9 member committee in voting for an interest rate hold at 0.5%. This all but eliminates the chances of monetary tightening this year and pushes back bets towards the back end of next year, if at all.
Nonetheless, sterling is trading very strongly against both the euro and particularly the US dollar. Much of this is due to the pound receiving an increased share of safe-haven flows. With doubts over the US credit rating and building concerns of another US recession, as well as fears of currency intervention with regard to the yen and the swiss franc (major safe haven currencies), sterling has acquired its own haven status.
With the dollar likely to remain weak in the long-term, particularly if further QE is signalled by Bernanke on Friday, sterling’s prospects have improved significantly across the board.
There is plenty of risk with regard to eurozone data this week; we have a raft of PMI data released tomorrow, as well as forward-looking German economic sentiment and business climate data. The economic picture in Germany and the eurozone as a whole has taken a turn for the worse in light of last week’s poor GDP figures (0.1% and 0.2% respectively). If weak eurozone data puts eurozone debt back under pressure, then market nerves will rise once again.
Sterling is trading at $1.65 and €1.1450 at present. Risks on both pairings this week are to the upside, while the EUR/USD pairing should remain somewhere near current levels of $1.44.
End of week forecast
GBP / EUR 1.15
GBP / USD 1.66
EUR / USD 1.4430
GBP / AUD 1.57
Richard Driver
Senior Analyst – Caxton FX
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