With hopes raised for a long-term strategy to deal with the eurozone debt crisis, October saw the euro rebound strongly from its late summer decline. Merkel and Sarkozy pledged action and to some extent delivered at last week’s EU Summit. Three major issues were addressed; the European banking sector is to be firmed up with a €110bn recapitalisation, the eurozone bailout fund (the EFSF) is to be expanded by almost five times to around €1trn, and it was agreed that there would be a 50% haircut on Greek bond holdings. The euphoria surrounding the progress has come down with a crash, with Greek Prime Minister Papandreou announcing a referendum on Greece’s recent bailout deal. There is a constant flurry of headlines out of Greece at present, and the latest suggest that the referendum may now be avoided. Regardless, with so much uncertainty surrounding Greece’s government, a messy Greek default remains a distinct possibility and has been reflected in a euro decline.
Heightened uncertainty has seen safe haven assets such as the US dollar come back into favour. We have seen the euro bounce back from much lower levels than the ones we are seeing at present, but the probable delay to progress caused by Greek politics may well see risk appetite hemmed in for at least this month. Sterling and the dollar have plenty of factors weighing on them, but in the current climate of financial market turbulence and global economic slowdown, the current task of the market is to find the ‘least unattractive’ options.
Sterling/Euro
Third quarter UK growth came in at 0.5% on Tuesday; an encouraging showing on the surface but the market was more concerned with an awful UK manufacturing figure for October (the lowest since July 2009). With the UK services sector also slowing down alarmingly in October, the UK economy looks highly likely to suffer a slowdown in the final quarter of this year and a dip back into recession looks to be very much on the cards. This is likely to see the Monetary Policy Committee step up its quantitative easing programme, which was only recently increased in October. We are currently looking for yet more QE early in 2012, which will no doubt dampen sterling’s appeal in the longer-term should it come to fruition.
However, the euro is facing even graver issues. Just when market confidence had returned following some major decisions at the last EU summit, the Greek issue has returned to jeopardise all the progress that was made. The prospect of waiting several weeks for a Greek election or a referendum (as yet it’s unclear which one, if either), which could conceivably produce the outcome of a Greek euro-area exit and disorderly default, has seen risky assets such as the euro plummet once again. It is a dangerous game to base exchange rate predictions upon knife-edge political votes. Fortunately this won’t be necessary just yet as any vote, be it an election or a referendum, will not come this month.
This pair has made another attempt at the €1.17 mark this week but was rejected. Any foray too far away from the €1.15 level is proving to be fairly fleeting, and we are now trading a cent lower. The euro has also come under some selling pressure as a result of a 0.25% ECB interest rate cut, which reduced the euro’s return differential. However, once the dust settles on this surprise move, it may be seen as a wise and assertive move to help deal with the eurozone’s economic problems.
Assuming risk appetite remains hemmed in this month as a result of the ongoing Greek tragedy and safe-haven demand for UK gilts remains elevated, the euro looks hard-pushed to sustain much of a rebound. Headlines and developments out of Greece will be crucial but the weeks ahead should see the GBP/EUR rate trade predominantly in the €1.15-1.17 range, with a chance of a climb even higher.
Sterling/US Dollar
Last month’s dollar rally proved something of a false dawn. The dollar was unable to sustain its move down to the low $1.50s due to some positive headlines out of last week’s EU Summit and the resulting recovery in global stock indices. Still, the prospects for the dollar look positive for the coming month, in light of the huge uncertainties surrounding Greece’s political and fiscal situation, as well as ongoing declines in global economic data.
US Federal Reserve Chairman Ben Bernanke has asserted that overall growth strengthened in the US over the third quarter, but as usual he emphasised the “downside risks” moving forward and downgraded his growth forecasts. In particular, he was bearish on the outlook for the US labour market over the next two years. It is looking less a case of if, but when the Fed pulls the trigger on QE3. Nonetheless, we are probably looking at Q1 2012 at the earliest, which should not impact too much on the dollar’s performance this month.
The EUR/USD pairing will as ever provide much of this pair’s direction. Our bet is that the dollar will outperform the euro this month, which is likely to prevent GBP/USD making any sustained moves north of the $1.60 mark.
Caxton FX one month forecast:
GBP / EUR 1.17
GBP / USD 1.58
EUR / USD 1.35
Richard Driver
Senior Analyst – Caxton FX
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