UK Q2 GDP contracts by less than expected: things are looking up

The final UK GDP figure has been announced this morning and the news was very good; the UK economy only contracted by 0.4%, less than than the previous -0.5% estimate and considerably less than the original -0.7% reading. So in simple terms, the UK economy was only around half as bad as first thought in Q2. An upward revision to the construction sector’s performance is a key cause of the upward revision.

The Bank of England reckons that the extra bank holiday for the Queen’s Jubilee in June cost the UK economy as much as 0.5%, so underlying growth could actually have been positive in Q2. There is a big difference between stalling growth and deepening recession. Today’s upward revision really dovetails with what Mervyn King has been saying for the last few months. The figures released by the Office of National Statistics (the GDP figures) have underestimated UK growth, or at least overestimated the impact of the Jubilee bank holiday.

UK figures have been showing some significant improvements this summer, helped by the Olympics, and MPC member Fisher has commented today that we can expect a “very strong” GDP reading for Q3. In fact, we are expecting Q3 growth to more than make up for Q2’s contraction, perhaps showing a reading as high as 0.7%.

Of course, downside risks should be noted and the UK is a long way from being out of the woods and free from recession fears. The eurozone debt crisis continues to pose a threat to our banking system and it is certain that eurozone growth will be more or less non-existent next year. Nonetheless, this morning’s figure is good news and October 26 will bring more in the form of a robust preliminary Q3 GDP reading. All good news for the pound, which has already enjoyed a rally today, trading above €1.26 and $1.62. 

Richard Driver

Currency Analyst

Caxton FX

Will the ECB cut interest rates next week?

Away from what’s going on in Spain and Greece, let’s take a look ahead at next week’s ECB meeting. This week’s key German business climate figure was awful and the significance of this will certainly not have been lost on the ECB. With economic contraction throughout the periphery weighing on growth in the eurozone’s powerhouse economy – will the ECB finally put its deeply engrained fear of high inflation to one side and give Germany and perhaps more importantly the rest of the eurozone a helping hand by lowering interest rates?

A German contraction in Q3 is not a certainty but it is now looking likely, particularly in light of the latest German confidence figure, which hit its lowest reading since March 2010. Spain’s central bank warned yesterday that its economy’s GDP continued falling at a “significant rate” in Q3, while S&P forecasted that Spanish GDP will contract by another 1.4% in 2013 and the eurozone economy a whole will achieve zero growth. With conditions so dire in Germany’s major eurozone trading partners, you don’t have to dig too deep to find motivation for a rate cut.

Domestic consumption, which accounts for around 60% of German GDP, is in good shape and consumer confidence remains stable. Admittedly, other domestic German indicators such as the ZEW and PMI surveys also suggested things are not so bad but we can probably put this down to temporary positivity triggered by the ECB’s bond-buying plan. The German business climate survey has built up a strong correlation with German GDP, which leads us to believe a Q3 contraction is on the way. Weak exports are likely to outweigh robust domestic demand.

Still, the ECB seems unlikely to cut interest rates next week. The ECB appears to have already factored in further weakness in eurozone growth; recently projecting a 2012 GDP contraction of between -0.6% and -0.2%. This latest poor figure from Germany probably does little to change the ECB’s approach. Indeed Draghi acknowledged a weaker business cycle in his September ECB Press Conference.

In addition, the ECB’s Nowotny has recently stated that he “sees no need to change interest rates in the eurozone currently.” ECB policymakers have also been lauding the positive response in the financial markets to the ECB’s bond-buying plan, suggesting they are satisfied with the 0.75% interest rate at present. Draghi will also be eager to keep the German ECB policymaker Weidmann on side by waiting until a rate cut is absolutely necessary, when German growth has completely ground to a halt and inflation has eased further. This is likely to happen later on in Q4, perhaps in December. The euro is certainly feeling the pressure at present but it will likely be spared the downside factor a rate cut for the time being.

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Round-Up: Spanish bailout issue to weigh on euro

Market frustrations with Spain on the rise

Spanish PM Rajoy’s failure thus far to accept the inevitable and make a formal request for a bailout has weighed on the euro in recent sessions. The week ahead brings plenty of interest; we are due to see Spain’s draft budget for 2013, the results of the Spanish banking sector’s recent stress tests and an economic reform programme that is likely to be a prelude to a bailout package. Even if these developments are welcomed by the market, we still think that Rajoy will wait until after Spain’s regional elections on October 21, which leaves several more weeks of uncertainty and frustration. This should delay any further euro rallies.

On the Greek front, we have seen some alarming headlines that the budget deficit is nearly twice as large as initially estimated. Talks between Greece and the Troika are now on a one week hiatus, so the market is left with alarming rumours of the need for a third Greek bailout and another Greek debt restructuring. The option of granting Greece more time to meet its bailout targets is gaining support but at this stage we are very much in speculation territory.

Concerns over eurozone growth have returned to the fore this week, after another awful German business climate survey. The risks of a German recession are rising, a development which the periphery can ill-afford.

Sterling firm ahead of final GDP number

The pound is performing well across the board at present. Eurozone concerns have returned after an August lull, while the central banks of Japan and the US have both eased monetary policy further, leaving sterling to reap the rewards. In addition, UK data has improved in recent weeks and the BoE seems to be content for the time being to delay any further QE of its own.

Sterling should be able to hang on to its recent gains against the euro and perhaps even build upon them, provided that Thursday’s final UK GDP number for Q2 does not suffer a downward revision to the already worrying   -0.5% reading. This release, which is likely to remain unrevised, is the only major event on the domestic calendar this week. By and large, the market’s gaze will be firmly fixed upon Spain.

US dollar soft after QE3 decision but continues to look poised for a bounce

Sterling remains at heady heights close to a 13-month high against the US dollar, thanks in no small part to the Fed’s decision to do a third round of QE earlier this month. However, the dollar’s behaviour since the decision suggests the move was more than a little bit priced in. Certainly the pound has climbed against the greenback but it has really stalled at the $1.63 level, so much so that we expect the rate to fall back in the coming weeks (provided that Rajoy doesn’t surprise us with an early bailout request)

End of week forecast

GBP / EUR	1.2625
GBP / USD	1.6150
EUR / USD	1.2800
GBP / AUD	1.5600

Risk appetite is pretty weak at present and the flow of news out of the eurozone is predominantly very negative. There remain disagreements over the EU banking union, over the legality of the ECB’s bond-buying programme, over the cession of Catalonia from Spain and much more besides. With this in mind, the GBP/USD rate’s ceiling of $1.63 looks likely to hold firm in the coming sessions. Meanwhile against the euro, sterling looks better placed to climb further. A move back up above €1.26 is a likely one this week.

Richard Driver

Currency Analyst

Caxton FX

German confidence tumbles again, pointing to possible German recession

A monthly German survey, which covers around seven thousand firms, has been released this morning to reveal that German business confidence has declined for the fifth consecutive month. A flat reading was expected but German business confidence has now dipped to its weakest level seen since March 2010. The news provides further evidence of the dampening effects of the eurozone debt crisis on the region’s powerhouse economy and has accordingly weighed on the single currency today.

Firms in manufacturing, construction, trade and industry were mostly responsible for the poor climate reading, though retail and wholesale trade did improve slightly. The regional downturn is having a particularly noticeable impact on Germany’s exports to other eurozone nations. The economic weakness being seen in major nations like Spain, Italy and even France cannot be viewed in isolation; recessions are particularly contagious in a currency union like the eurozone and this morning’s data indicates that Germany is succumbing.

Interestingly though, an economist from the producers of the data - the Institute for Economic Research - has stated that German consumption remains robust despite a weaker labour market and therefore does not see a need for an interest rate cut from the European Central Bank. An interest rate cut would however weaken the euro, which could boost exports outside the eurozone, though this would require Germany’s preoccupation with high inflation to be set aside. The IFO economist did also note that the survey was taken prior to the positive decision from the German Constitutional Court earlier this month, the uncertainty surrounding which may be at least partly responsible for the unexpected decline.

The economic downturn is not just bad news for Germany but for the eurozone’s peripheral nations as well. If Germany enters recession, then it is going to be increasingly difficult for Merkel to justify and deliver the support she is pledging for struggling nations like Spain and Italy. With plenty more austerity measures still to come across the eurozone, the prospects for the economy as a whole and Germany by association, are rather gloomy. After Q2’s 0.3% GDP growth, Germany may avoid economic contraction in Q3 but the same is unlikely to be true in Q4, such is the downtrend that is in place. This is not to say that Germany is certain to enter a recession but the risks are very significant and it is looking increasingly likely, which is bad news for all concerned.

We may have seen some progress on the debt crisis in the last month or so but economically, the region is in very poor shape indeed, which is in part why we maintain a negative outlook for the euro.

Richard Driver

Currency Analyst

Caxton FX

Spanish bailout will come but not for another month

The newswires have today been full of speculation over the imminence of a Spanish bailout. The FT has reported this week that negotiations between Spain and the EU are going places. The two parties are working on an economic reform programme which is rumoured to be unveiled next week. Note though, this is only a prelude to a bailout request.  

What is Spanish PM Rajoy waiting for? Well, regional elections in the Basque country and Galicia are being held on October 21 and Rajoy is likely to wait until after that, as a bailout request before this date would more likely than not damage his Conservative party’s chances. This end of October period coincides with some major Spanish debt repayments and is probably as long as the market is willing to wait for some concrete progress.

There is something to be said for getting in early with a bailout request whilst bond yields are away from their record highs, so that Rajoy is in a better position to negotiate favourable bailout conditions. If Rajoy waits until the situation returns to panic mode, Spain’s creditors could have him over barrel.

Next Friday’s release of the Spanish banking sector’s stress tests could well spook the markets and send bond yields soaring up to 7.0% again but on balance we expect Rajoy to wait until late October, just in time for the ECB’s meeting in the first week of November. This leaves time for bailout conditionality to be ironed out between the interested parties.

We believe Rajoy will use the next month to try everything he can to achieve the best result for his country. He is under huge domestic political pressure by an increasingly angry and volatile population and cannot afford to be seen to sacrifice more than is absolutely necessary in return for a bailout. Everything should be in place by the end of October and until then, the euro is likely to come under increasing selling pressure.

Richard Driver

Currency Analyst

Caxton FX

Bank of Japan follows suit and eases monetary policy but the yen remains strong

 Last night’s monetary policy decision from the Bank of Japan saw further support provided to the Japanese economy. The BoJ added to its existing asset purchase programme by Y10trn, taking the total purchases to Y80trn. This Y10trn increase has come earlier than many expected and was certainly more than most market players expected. BoJ also extended the deadline for the end of the programme by six months to the end of 2013.

Nerves over the global economy are a major factor behind the BoJ’s decision. The US recovery remains shaky, the risks of a Chinese hard landing are rising, while there is little doubt that the eurozone has not seen the worst of the current economic contraction.

Global conditions have contributed to what the BoJ has described as a “pause” in the domestic Japanese economy. BoJ Governor Shirokawa has said the Japanese recovery has been set back by six months thanks to a prolonged global economic slowdown. Exacerbating the domestic growth outlook is the fact that a territorial dispute between China and Japan threatens to disrupt trade relations, something Japan can ill-afford.

Also in the BoJ’s mind will be the desire to curb the appreciation of the yen, which is hurting the Japanese economy. Particularly in light of the US Federal Reserve at last announcing QE3 this month, another move from the BoJ was always likely. However, the yen hasn’t weakened off today as much as the Japanese official would have liked. It has retraced almost all of last night’s losses, which demonstrates that there is no guarantee that QE will weaken a currency. 

Richard Driver

Currency Analyst

Caxton FX

RBA signals interest rate cuts in October

The Reserve Bank of Australia released the minutes from its September meeting last night and the Australian dollar has since weakened. This is because the minutes were probably the most dovish we have seen from the RBA in six months, suggesting a cut to its 3.50% interest rate could be just around the corner. To say the RBA has signaled a move may be an overstatement but the we are hearing the hints loud and clear.

The minutes included the assertion that "the current assessment of the inflation outlook continued to provide scope to adjust policy in response to any significant deterioration in the outlook for growth." This is a telling statement.

Australian data has not overall been particularly positive of late but it is hardly reason for the RBA to panic. Indeed, the RBA appears to be confident that domestic growth is on the right path. Investment looks to be positive for the rest of the year, consumer confidence is up and the unemployment picture is relatively stable, as shown by the recent fall to 5.1%.

Rather, evidence of renewed weakness in the Chinese economy is a major driver. Linked to this is the second issue on the RBA’s mind, which is declining commodity prices, in particular iron ore and coal prices. It’s not just China that the RBA is concerned with either; data from the eurozone and the US is also pointing to a further global slowdown.

So the bank has changed from a neutral tone to an easing bias. The comments reflect those within the RBA’s March meeting, which was followed by a 0.50% interest rate cut in April. We don’t expect a 0.50% cut in October, but we do expect a 0.25% cut, and then another in November or December. The Fed and the ECB’s recent monetary policy decisions will surely aid global growth eventually but this will take time to feed through and results won’t come soon enough for the RBA.

Richard Driver

Currency Analyst

Caxton FX

Rejection of further austerity leaves Spanish bailout in limbo

Spanish PM Rajoy has made no secret of his aversion to EU-dictated austerity measures in return for a bailout. The financial markets and Germany in particular are demanding further Spanish cuts but Rajoy’s response last week was; “"I will look at the conditions but I would not like, and I could not accept, being told which were the concrete policies where we had to cut." His country's economy is already in shreds after a July austerity-drive. 

Thousands of angry Spaniards marched in protest in Madrid over the weekend, demanding a referendum to decide on the government’s measures. Tensions and unrest in the country are at such levels now that Spanish finance minister Luis de Guindos has responded by ruling out further spending cuts. He said “Spain's existing measures are significant and ambitious enough” to meet the EU’s target of a budget deficit that 3.0% of GDP by 2014. It is common knowledge that Mr de Guindos is quite incorrect in saying this, and he well knows it, but it is in his country’s interest to keep up the charade.  

But where does this leave Spain with respect to the European Central Bank? Whilst the market went wild for the ECB bond-buying plan just over a week ago, the fact remains that Spain must officially request a bailout if it is to benefit from the plan. It will not do so if Germany’s demands are too onerous.

The announcement of the ECB’s bond-buying plan has bought Spain a little bit of time by bringing borrowing costs down, coming way down from the 7.0% level (10-year debt). Nonetheless, yields are back on the rise and the clock is very much ticking. Deposits are being withdrawn from Spanish banks at an alarming rate amid the current crisis of confidence, which will necessarily constrict the banks’ ability to support much-needed economic growth with lending.  

In an indication that Spain is edging towards a bailout request, it has pledged to unveil a reform programme on September 28, which will include clear deadlines and intended structural changes. We are still in the dark over bailout terms though and this is likely to be a huge source of uncertainty in the coming weeks. 

And how has the euro started the week? Well its rally has stalled, as it consolidates on last week's hefty gains. However, the market euphoria with respect to the ECB pledge to flash the cash and the Fed's decision to pull the trigger on QE3 may well give the euro further support in the coming sessions. 

Richard Driver

Currency Analyst

Caxton FX

Swedish Krona set for further losses

The Swedish krona continues to trade at impressive levels across the exchange rates. The krona has been boosted by an ongoing recovery in market confidence, driven in particular by some key breakthroughs in the eurozone. This confidence has fed into sustained appetite for higher-yielding currencies like the SEK.

The key development from Europe this summer has been the ECB’s pledge to provide unlimited bond-purchases for peripheral eurozone countries like Spain and Italy, whose soaring borrowing costs have been a major feature this year. The ECB’s pledge has already had a very positive impact on eurozone bond yields and has eased some of the more immediate concerns that the debt crisis may spiral out of control before EU leaders can react. The improved global sentiment has been given another boost by the German Constitutional Court’s approval of the European Stability Mechanism, which is to be the eurozone’s permanent bailout fund. While the issue of firepower is by no means solved, the eurozone’s ability to respond to Spain and Italy’s refinancing needs has certainly improved.

Sentiment towards the Swedish economy remains broadly positive, which isn’t surprising given the outstanding Q2 GDP figure released in late July, which smashed forecasts. 1.4% quarterly growth is probably more than most G10 economies can hope to achieve throughout 2012 as a whole. Domestic consumption remains in good shape and the Swedish export sector’s continues to stand up pretty well in the face of deteriorating growth and demand in the eurozone. However, there has been some recent economic weakness that may persuade many investors to give up on hopes for any further SEK rallies.

GBP/SEK Outlook

The situation in the UK has been fairly grim this summer, with data confirming that on top of Q1’s 0.3% contraction, the UK economy contracted by another 0.5% in the second quarter, with the extra Bank Holiday as a result of the Queen’s Diamond Jubilee weighing particularly heavily.

However, the UK economy is showing some solid signs of turning a corner in Q3. Industrial and manufacturing production data has shown some excellent growth, the UK services sector bounced back in July, while the latest trade balance and labour statistics have also been very positive. Thanks in no small part to the London Olympics, there is now a decent chance of a positive Q3 GDP figure, which should result in some support for the pound.

Also supportive of the pound is the near-term outlook for Bank of England monetary policy. The BoE appears content to sit it out and wait for the effects of both its Funding for Lending programme and its last QE top-up, before easing monetary policy any further. Conditions in the eurozone have eased up, while domestic activity has improved in the past couple of months, which should ensure there is no more QE until November at the very earliest.

There is no doubt that the Swedish spent Q2 in rude health but there have been some mildly concerning figures released of late. August saw a surprise rise in unemployment to 7.2% from 7.0% and a very weak manufacturing growth figure, while the latest industrial orders data suggests there could be some further weakness down the line. However, it was weak Swedish inflation, not tame growth figures, which prompted the Riskbank to cut its base rate by 0.25% to 1.25% in September.  While Swedish krona’s interest rate differential has now been eroded, the market’s response was quite muted.

This pair posted fresh multi-month lows in the past fortnight, amid a series of positive eurozone developments. However, support levels have kicked in at 10.5, which has coincided with stronger UK figures and a slight loss in momentum in Sweden. These factors should combine to send GBP/SEK pair higher off these current lows in the coming month. 10.7-10.8 is a decent target area.

Richard Driver

Currency Analyst

Caxton FX

Swiss National Bank holds firm on EUR/CHF floor

Away from the wild speculation surrounding the US Federal Reserve’s meeting this evening and away from the strides being made in the eurozone, the Swiss National Bank gave its quarterly monetary policy assessment this morning. As expected, the SNB kept interest rates on hold in the 0-0.25% band. Slightly more interesting than this, however, was the SNB’s decision to reiterate its commitment to defending the EUR/CHF floor (or ceiling if you prefer to look at it that way) of 1.20.

Since the escalation of the eurozone debt crisis, the safe-haven franc attracted huge investment and the excessive appreciation that this caused was damaging to the Switzerland’s economy. In August 2011, the Swiss National Bank responded by intervening in the currency markets to weaken the franc (put simply, buying lots of euros and selling lots of francs). In September 2011, the SNB set a floor for the EUR/CHF exchange rate, pledging to use all the resources at its disposal not to allow the franc to strengthen past this point (below a rate of 1.20).

Since September 2011 then, any dip below the 1.20 threshold has been fleeting and marginal, but the market has certainly tested the SNB’s resolve. Central banks currency intervention is historically very unsuccessful and expensive, just ask the Bank of Japan. Up until now though, the SNB is doing a remarkably good job but only time will tell. 

Swiss National Bank's statement this morning has told us that they expect the Swiss economy to grow by 1.0% this year, down from the 1.5% growth they expected three months ago (though this is still a decent pace of growth). In addition, the SNB also sees consumer prices falling by 0.6%, more than initially expected, with inflation expectations for 2013 and 2104 also downgraded. 

In light of downgraded growth and inflation expectations, the SNB was quite clear on its on-going commitment to maintain the EUR/CHF floor this morning, stating that “If necessary, it stands ready to take any further measures at any time.” It’s not surprising either, the swiss franc remains overvalued. With near-term risks to Swiss growth high given the poor growth outlook for the eurozone economy, the SNB is likely to maintain its defensive stance in the medium term. However, talk of shifting the floor even higher up to 1.25 looks unlikely to be realised, as the SNB will probably view this as too risky. 

Richard Driver

Currency Analyst

Caxton FX

The German Constitutional Court gives the euro another boost

After weeks and week of delay, Germany’s top Constitutional Court has ratified the European Stability Mechanism - the eurozone’s permanent bailout fund. The court ruled that the ESM does not conflict with the German constitution and Italian PM Mario Monti has today stated that this “has removed the last obstacle for the implantation of the ESM treaty and the fiscal compact treaty.”

There are a few ‘buts’ though, which probably means Monti is jumping the gun a little. Whilst the ESM treaty does oblige the German government to contribute €80bn up front and further contributions upon bailout requests down the line, the German court has limited Germany’s contribution to €190bn. This is a significant condition and may prove to be insufficient given the refinancing needs of Spain and Italy. Italy could potentially decide to it is unable to contribute to the ESM due to the state of its own finances - Germany is unlikely to step willingly into the void. In addition, the court rejected granting the ECB a banking license and in doing so highlighted a continuing lack of firepower.

However, Germany's liability could be increased with the approval of the Bundestag, though such approval seems unlikely given the momentum of bailout-fatigue sentiment among the electorate. Another condition was included that both German House of parliament must be kept informed of ESM decisions, which does have the potential to delay future decisions.  

The ESM’s governing board will meet in early October for the first time but Eurogroup head Juncker has said it will not be activated before January 1, 2013. The euro has rallied again today, focusing on the disaster that was avoided rather than the considerable issues that remain. The euro may be to climb a little further on the back of a QE3 announcement tomorrow evening but it is fair to say this rally is looking increasingly overextended. 

Richard Driver

Currency Analyst 

Caxton FX

UK trade deficit narrows to an 18-month low

Trade balance data for July has revealed this morning that the UK trade deficit has narrowed to a February 2011 low of 7.1B. This was lower than the 8.9B deficit that was anticipated and significantly lower than the 10.1B deficit shown in August. 

At 9.0%, overall export sales growth was at its highest level since 1998. Sales of goods outside the eurozone grew by 11%, while somewhat surprisingly, sale of goods to the eurozone even grew by almost 8.0%. More positive news for the economy, then, and it certainly takes some of the considerable pressure off the UK government.

It is encouraging to see UK businesses respond to the challenges facing them, in the form of low confidence and deteriorating economic conditions in the eurozone, by diversifying their global trade relations. Increased take-up from the US, Asia (especially India) and South Africa all contributed to this morning’s improved figure. Oil exports to the eurozone was also a key factor in helping the July trade balance bounce back from June’s disappointing showing, which was the worst since modern records began 15 years ago.

Once again this points to a rebound for UK GDP in the third quarter. Awful trade balance figures were a real drag on growth last quarter, which unless we see another dramatic reversal in August and September, will not be the case in Q3. It goes without saying that this figure does not change a very uncertain outlook for UK exporters. The flow of bad news out of the eurozone has been stemmed somewhat over the summer but for as long as the region’s economy contracts, a cloud will remain over many UK businesses. Nonetheless, this is again good news for the UK and no doubt Chancellor George Osborne will sleep a little easier tonight.

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Outlook: Further upside potential for euro

ECB plan triggers euro rally

Mario Draghi alluded to doing “whatever it takes” to save the euro a month or so ago and at last week’s ECB press conference, he outlined just what he meant by that. ‘Super Mario’ as he has been called, revealed a plan that involves the ECB purchasing unlimited amounts of peripheral eurozone nations’ bonds. This has already brought down Spain’s bond yields but as Moody’s has warned today, this does not solve the crisis, it merely buys EU politicians (and not the ECB) the time to address the region’s fiscal and structural shortcomings.

The ball is now effectively in Spain’s court to negotiate acceptable conditions of a bailout that would include ECB intervention in the bond markets. So we are back to the familiar balancing act of Germany extracting sufficient austerity measures without going ‘over the top.’ This could potentially weeks but there is plenty to watch out for in the interim.

Wednesday should bring the German Constitutional Court’s ruling on the legality of the European Stability Mechanism and the eurozone’s fiscal compact. The court is strongly expected to approve both initiatives but a complaint made today by a German MP regarding last week’s ECB bond-buying plan has raised the prospect of another possible delay to the decision, which has ramped up market nerves again.

Wednesday also brings the Netherlands' general election but the euro looks likely to be spared another political saga at this stage, with the latest polls indicating a close race between two pro-Europe parties.

QE3 could finally arrive this week

Going into last Friday’s non-farm payroll figure the chances of the Fed delaying QE3 for the time being were fairly well balanced but it now seems highly likely that Ben Bernanke will at last pull the trigger on Thursday. Ironically, data did reveal that the US unemployment rate did fall to a rate not bettered since January 2009. Unfortunately as the employment change figure revealed, this was not because more jobs has been taken up and will be of little comfort to the Fed. QE3 is priced into a decent extent after Friday’s dollar sell-off but there is every chance we could see another wave of risk appetite give the greenback another knock this week.

Hints of a Q3 rebound for the UK economy

 August’s PMI growth figures from the manufacturing and services sectors were much better than expected last week. In addition, data also revealed that UK manufacturing and industrial production grew at their fastest rates in 10 and 25 years respectively, bouncing back from June’s slump. This summer’s London Olympics also look likely to have made quite a sizeable contribution to the domestic growth, which has caused many to revise up their GDP forecasts for Q3. All this means that QE concerns should not apply any weight to the pound for the next few weeks at least.

Although the euro’s upward climb has stalled today, the prospect of QE3 from the Fed and a positive ruling from the German Constitutional Court could well give the single currency some further strength. This is likely to keep the GBP/EUR pinned close to or even temporarily below the €1.25 level. Against the USD, matters are rather different as the pound currently sits only marginally off a near-fourth month high. Renewed upside potential for the EUR/USD pair could well help the GBP/USD hang on to these gains in the short-term but we continue to expect a reversal in the coming weeks.  

End of week forecast

GBP / EUR	1.2450
GBP / USD	1.6050
EUR / USD	1.2890
GBP / AUD	1.5300

Richard Driver

Currency Analyst

Caxton FX

More good news flows from the UK economy as industrial and manufacturing production picks up

Data this morning has revealed further encouraging news from the UK economy. The figures show that manufacturing production grew by 3.2% in July, while UK industrial production grew by 2.9%, which represents the strongest monthly improvements in 10 and 25 years respectively. While we remain in a double-dip recession, such improvements take on a greater importance and should be celebrated.

Naturally though, the data on its own does not tell the whole story, as July’s figures come on the back of an extremely weak performance in June. Nonetheless, the figures far exceeded expectations and undeniably point to a decent start to the second half of the year in those sectors.

There is no doubt that the UK manufacturers have plenty of tough times ahead, with economic conditions in the eurozone deteriorating. Only yesterday, the ECB downgraded its GDP forecasts. In June the bank saw eurozone GDP for 2012 falling in a range of -0.5% to 0.3%, now its sees it falling somewhere between -0.6% and -0.2%. The bank also foresees a significant risk of another economic contraction in 2013.

In this environment, it is difficult to see UK manufacturing and industrial production being a major driver of UK growth in the year ahead. However, there are signs that the sectors can maintain a mild uptrend, which is something to be thankful for. It could well help the UK bounce out of recession in 2013. 

This should dampen concerns surrounding the Organisation of Economic Cooperation and Development’s latest prediction that the UK economy will contract by -0.7% this year. Combined with the strong UK manufacturing and services sector PMI’s for August, improvements in the labour market and retail sales, Q3 looks to have started very well with the help of the London Olympics. This is good news for sterling, as the Bank of England may well decide not introduce any further QE when it next properly considers the option in November. 

Richard Driver

Currency Analyst

Caxton FX

September Monthly Outlook: GBP/EUR, GBP/USD

August was another strong month for the single currency as the financial markets continued to take comfort in ECB President Draghi’s pledges to do “whatever it takes” to save the euro. There were no major swings among the major pairings, with August typically being a sleepy month where traders and policymakers alike take their summer vacations. Despite a recent upturn in US economic figures, the dollar remains on the back foot, with QE3 speculation more prevalent than ever.

Recent domestic data suggests conditions have improved somewhat in the past month, which gives hope to the market and consumers that the UK economy can yet stage some sort of recovery in the second half of the year. The Bank of England will be content to see how this bounce in activity progresses, so fears of imminent quantitative easing should subside for the time being. Moreover, with a busy calendar for the US and the eurozone in the coming weeks, the UK economy is very much out of the spotlight at present.

The month ahead could well be a pivotal one in the timeline of the eurozone debt crisis. We are seeing the European Central Bank preparing to launch a programme of unlimited bond-purchases as part of a wider bailout package for Spain. The pressure will now build on Spanish PM Rajoy to make the necessary request for help but the conditions Germany pushes for is likely to be subject to tense negotiations.

Next week (September 12) brings the long-awaited decision from the German Constitutional Court on the legality of the European Stability Mechanism and the fiscal compact agreed earlier in the year, around which there is considerably uncertainty. There is also plenty of political risk in the form of a general election in the Netherlands, while the Troika will spend much of September assessing Greece’s attempts to reform before deciding on whether to release the essential next aid tranche. In addition to all these eurozone events, we will learn whether the Fed will finally pull the trigger on QE3 this month.

GBP/EUR

Sterling remains at strong levels against the euro; it is quite clear that the market has spent recent weeks waiting to see how September’s events panned out before punishing the euro any further. Indeed, whilst decisions and concrete actions have yet again been conspicuous by their absence, comments from ECB policymakers and eurozone political leaders have been falling on sympathetic, or rather, hopeful ears. This has fuelled a rebound for the euro.

Signs of life in the UK economy

The UK economy has enjoyed some good news in the past week in the form of some better than expected manufacturing and services sector growth figures, with the latter in particular raising hopes for a recovery. UK unemployment continues to make progress, with the jobless rate falling to an 11-month low of 8.0%. However, the market will need more convincing that the worst of this double-dip recession is behind us before sterling really begins to reap the benefits of improved data. The initial Q2 GDP figure of -0.7% was revised up to -0.5% but confidence is understandably still very fragile. The Bank of England looks content to remain in ‘wait and see’ mode with respect to the need for further QE, so the risks to sterling in this regard are limited for at least the next month.

Will Super Mario save the day?

Positivity surrounding an imminent bond-purchasing plan to deal with soaring Spanish and Italian borrowing costs has been the key feature of the debt crisis in the past few weeks. Timescales as to the launch are immensely tricky to pin down due to the need for Spain to request help from the ECB but the central bank’s fire-fighting measures are likely to be seen a positive for the euro when it does finally come about.

However, these unconventional measures do little to address the fundamental issue at the heart of Spain and Italy’s predicament – their lack of competitiveness. The eurozone periphery cannot bounce back with the euro as overvalued as it continues to be (regardless of the depreciation we have seen this year). Indeed the ECB’s commitment to fire-fighting this summer has exacerbated the situation by strengthening the euro. Crisis management policies like bond-purchases will not see the eurozone through this crisis. We have seen this year that ECB interest rate cuts weaken the euro and for us, it is only a matter of time before the ECB takes this option again, finally putting concerns over inflation to one side. The incentive to cut rates is all too clear; the ECB itself has this week significantly downgraded the eurozone’s growth prospects for both this year and next (possibly as low as -0.6% and -0.4% in 2012 and 2013 respectively).

The ECB and Germany’s opposition to granting the ESM a banking license also continues to stand in the way of any so-called ‘silver-bullet’ solution. Such a move would effectively give the permanent bailout fund unlimited access to ECB funding, eliminating the concerns that linger over inadequate firepower.

Huge risk events ahead in September

The next major obstacle in store is the German Constitution Court’s ruling on whether the new role for the ESM (the permanent bailout fund) and the eurozone’s fiscal compact complies with German law. If it does not, then this would be disastrous for the euro and while the probability is of a positive outcome, the risks to the contrary are significant. September 12 is made all the more important by the Netherlands’’ general election, which has been centred on the issue of the debt crisis. If anti-austerity parties do as well as polls are suggesting, then this is likely to weigh on the single currency.

Concerns over Greece are likely to come to the fore again this month, as the Greek coalition struggles to work through another €11.5bn of spending cuts and as the Troika returns to complete its review of Greece’s efforts to address its fiscal position. A positive Troika report is necessary in October if Greece is to receive its essential next emergency loan, without which it will default and most likely exit the eurozone.

Sterling may well have another slow month against the euro in September as the market prices in a (temporary) resolution to Spain’s crisis. However, we do see this pair resuming its uptrend beyond the short-term, slowly creeping higher towards, though probably falling short of €1.30 by the end of the year. €1.25 should provide plenty of support and we don’t see sterling weakening below this level but equally, provided the German constitutional court give a positive ruling on the ESM and fiscal compact, sterling could well spend much of the coming weeks below €1.2650. 

GBP/USD

Sterling is flying at a 3 ½ month high at present, despite the UK economy’s significant underperformance of its US counterpart. The QE3 issue continues to haunt the US dollar and delay what we continue to believe will be a robust end to the year for the greenback. There is no doubt that the US Federal Reserve has engaged in greater discussion of further monetary accommodation, with several policymakers convinced of the need of QE3. However, Ben Bernanke chose not to utilise his annual Jackson Hole speech to signal another round of QE, though crucially he said nothing to discount it.

Can the US dollar avoid QE3?

It does appear to be a case of ‘when’ not ‘if’ with regard to QE3. The Fed’s reasoning on QE3 seems to have changed from a stance of committing to more QE in the event that the US recovery deteriorates further, to a commitment to QE unless conditions markedly improve. Economic figures out of the US have been somewhat improved in the past few weeks, which may well convince Ben Bernanke to keep his powder dry on September 13. However, there is every chance that Q4 will bring the decision the market is hoping for.

The sounds out of the Bank of England in recent weeks have given the market some reason to look kindly upon the pound. A cut to the BoE’s already record-low interest rate has effectively been discounted and Mervyn King appears content to wait to see the impact of its Funding for Lending Scheme before introducing further quantitative easing. Whether or not more QE comes in November really depends on growth figures in the interim but the latest indicators do suggest a mild upturn.

Nonetheless, we continue to envisage a significant move lower for the EUR/USD pair in the coming months. If this comes about, it will weigh on the GBP/USD pair to a great extent. The euro’s rally against the USD is looking increasingly stretched at current levels of $1.2650 and given that we see this pair below $1.20 by the end of the year, we do expect GBP/USD to retreat significantly from the $1.59 level where it is trading at present. A rate of $1.57 is realistic in the coming few weeks. 

Richard Driver 

Currency Analyst 

Caxton FX

Roadmap to the Spanish debt crisis

This week is of huge significance to Spain and it might be interesting to give a brief roadmap of how Spain got into its current predicament. Up until 2008, the Spanish economy had been doing well. For instance, real estate prices rose 200% from 1996 to 2007 and the Spanish banking system (with small local banks known as ‘cajas’) had been viewed as one of the best equipped to deal with a financial crisis. Prior to 2008, some regions of Spain were very close to having full employment.

So what went wrong? In the third quarter of 2008, Spain’s economy officially entered recession, after 15 consecutive years of growth. Not a big surprise really, seeing as most countries around the world also went into recession during this period. Rating agency Standard and Poor’s then downgraded Spain’s prized AAA to AA+ in 2009. So, they adopt an economic stimulus plan worth about 5% of their GDP, which leads to the exiting recession in the first quarter of 2010. Things look optimistic.

Then investors start to take a closer look at the Spanish economy and realize that the public deficit is huge: 11.2% of their GDP. After admitting Spain was in trouble, Prime Minister Zapatero introduced austerity measures to address the problem. He raised the retirement age from 65 to 67, reformed pensions and passed a constitutional amendment forcing governments to maintain a balanced budget. Zapatero was then voted out in late 2011, and Mario Rajoy’s conservative party filled the void with an absolute majority.

However, the Spanish economy was already on a downward slide, having produced no growth in Q3 and suffering a 0.3% contraction in Q4 2011. By March, unemployment had doubled the Eurozone average by climbing to 24.4% (it now soars above 25%). In April, thousands protested across the country against the government cuts, adding political instability into the mix.

In the summer of last year the Spanish banking sector began to crumble. Bankia requested a €19 billion state rescue in May, which pushed Spain itself into requesting €100 billion bailout for the struggling banks. In July, one of Spain’s richest regions, Catalonia, requested aid from the central government and several more followed suit as the gravity of the crisis surfaced. With borrowing costs setting fresh record-highs, it has come to a tipping point which appears to have prompted action from the ECB.  

It goes without saying that the European Central Bank’s meeting in Frankfurt tomorrow could be crucial in the context of the Spanish and wider eurozone debt crisis. ECB President Mario Draghi has assured the market that the bank would buy enough bonds on the open market to put a stop to the “financial fragmentation” that currently exists throughout Europe. Draghi has hinted only this week that the ECB is free to buy government bond maturing in three years or less, without breaking the EU treaties and overstepping its mandate by stepping in to money-printing terrritory. This has already had a dampening effect on Spain’s soaring borrowing costs.

Whether the ECB unveils its plan to intervene in the bond markets on Thursday or not, it will do so fairly soon, that much has become pretty clear. But if a country wants to get their hands on this attractive offer from the ECB, they will first have to agree to a set of conditions. Just how strict these conditions are will determine how quickly Spanish PM Mariano Rajoy agrees to request help from the ECB.  He asserted last week, "When I know exactly what is on offer I will take a decision.” Rajoy will not be able to get the ECB’s help for free but certainly Merkel needs to be careful in not overstepping the mark when making austerity demands of Spain’s already crippled economy. There is bound to be plenty of brinkmanship involved if Spain is to request help.

Whilst the ECB meets tomorrow, Rajoy and Merkel will be also be meeting, where it is anticipated that the two leaders will be negotiating an estimated €300bn Spanish sovereign bailout. September was always ear-marked as an all-action month and it looks as if we could indeed be on the brink of some major developments. Whether or not the market will be convinced remains to be seen.

Harry Drake
Caxton FX

 

UK growth shows signs of bouncing back in August

In light of the early release of the UK services sector PMI figure, we now have a good picture of how the UK economy performed in August. After an awful slump in July to kick off the second half of the year, conditions in the UK clearly picked up in August.

UK construction remains in the doldrums, contracting in August for only the second time in twenty months. However, UK manufacturing growth was nowhere near as bad as expected, only marginally contracting compared to the rapid slowdown that was anticipated. Once again, the UK services sector appears to have bailed the UK economy out, showing some truly impressive growth – the best in five months.

This really suggests that the Bank of England’s prediction that the UK economy could bounce back in Q3 could be spot on. Still, declines being seen in the UK construction sector will remain a grave concern because while it is a relatively small segment of the economy, it has proven this year that it can weigh materially on GDP figures.

The upturn in the UK economy in the past month could well be Olympics-related, so the market will be right not to get ahead of itself. It certainly does not remove the possibility of the BoE deciding on further QE later this year. What it probably does do is put to bed any hopes or expectations that the BoE will do any further monetary easing on Thursday. More evidence will be needed if we are to have any confidence that we will see a sustained bounce back for UK GDP, but this is some rare good news from the domestic economy. Sterling has benefited accordingly as well, climbing half a cent today against the euro to reach €1.2650. 

Richard Driver

Currency Analyst

Caxton FX

Aussie dollar is struggling but tonight’s RBA should spare it another blow tonight

The AUD has suffered a 5.0% drop against the pound in the past month, as well as a 3.6% drop against a broadly weak US dollar. Weak Chinese data added to the negative regional tone evident in the Asian markets at present. The Chinese manufacturing sector contracted in August for the first time since November 2011 and by more than was expected. All is not well with Australia’s key export partner and data has been poor on the domestic front also. Data this week has revealed that Australian retail sales contracted by an alarming 0.8% in July. Understandably, the aussie dollar has fallen further out of favour as a result.

A key factor which is adding pressure to the AUD is the fact that iron ore prices have plummeted of late, in line with the deteriorating growth and demand outlooks for China. Interestingly, the Reserve Bank of Australia’s McKibbin has commented recently that “things have changed a lot in the last month…I now have further downside risks in my forecasts for interest rates.”

So what is the Reserve Bank of Australia going decide at its monthly meeting tonight? Well, ahead of an Australian GDP figure which is likely to indicate growth of around 0.9% during the second quarter, it is hardly panic stations. This is very backward-looking data though and the truth is that economic conditions in Australia have really declined in the third quarter. Nonetheless, very few will be expecting the Reserve Bank of Australia to cut its 3.50% interest rate tonight, and we are not among them.

It seems quite clear that the central bank is very much in ‘wait and see’ mode. RBA Governor Stevens recently emphasised that is “too early…to tell how much difference the sequence of decisions to lower interest rates has made to the economy." The RBA will be concerned with the Australian economy’s recent underperformance but not overly surprised, as downside risks to near-term growth were noted in August. Another rate cut is wholly possible, if not probable in Q4 (which could be brought forward if the Eurozone crisis drastically deteriorates), but the RBA will remain on hold for tonight. However, this is unlikely to provide the AUD with much relief.

Richard Driver

Currency Analyst

Caxton FX