The euro has enjoyed a remarkably strong start to 2012, rebounding considerably from what was a very steep decline at the end of last year. Greece has been the primary focus of recent weeks - talks stalled between Greece and its private creditors over a debt swap deal and the Greek coalition has struggled to agree on the necessary austerity measures. At last, a Greek deal has been announced, which should pave the way for a €130bn second bailout that will avoid a messy and potential disastrous Greek default.
Growth in the UK economy picked up a little in January, which has fuelled some hope that the British outlook may not be as gloomy as once feared. Growth will remain sluggish even in a best case scenario, so it was always a question of by how much, not if, the Bank of England would increase its quantitative easing programme at its recent meeting. £50bn of additional asset-purchases has been announced but sterling was unaffected as the move was fully priced in.
Despite building eurozone concerns, risk appetite is in fairly good shape at present and this has seen the US dollar weaken off in recent weeks. Nonetheless, we maintain a bearish outlook for risk assets this year and a bullish view of safer currencies such as sterling and the US dollar.
GBP/EUR
Sterling’s progress against the euro has stalled in recent weeks. The imminence of further quantitative easing has pegged sterling back somewhat. However, the key resistance factors for GBP/EUR have been some intense short-covering by a market that had bet heavily against the single currency and some relieving (albeit frustratingly slow) progress towards a second Greek bailout that will avert a default in March.
The current Greek situation remains highly uncertain however. The deal may broadly have been agreed but the Greek parliament still needs to approve it; it contains further crippling austerity measures, which will likely be a tough sell to Greek MPs.
Fears of another eurozone credit crunch have eased in recent weeks, largely due to the ECB’s cheap loan programme to ease credit lines. The cheap loans scheme (which will be replicated at the end of this month) is in effect quantitative easing through the back door and has filtered into the eurozone bond markets, resulting in lower yields across most of the periphery, most importantly in Spain and Italy.
However, Portuguese bond yields have not responded as the ECB would have liked, which indicates that another crisis scenario is just around the corner. Speculation is building that we will need to see another second bailout scenario in Portugal, whose bond yields are on a very similar trajectory to Greece’s last year.
The UK’s AAA credit rating and the demand of UK gilts remain the key drivers of any sterling strength. The market has made its peace with increased quantitative easing from the Bank of England and the issue shouldn’t weigh on the pound too much this year.
A plunge back into recession, of which there is a significant risk, is the main risk factor hanging over sterling. Negative growth combined with ongoing elevated debt levels will surely attract the attention of the rating agencies and the rug could well be pulled from under the pound. Still, some strong January growth figures, typically led by the UK services sector, suggest there is some room for optimism. Add to this the growth-friendly effects of further QE and a double-dip may just be averted.
GBP/EUR has consolidated around the €1.20 mark since the turn of the year and we don’t envisage any major or sustained forays below this level. 84p (or €1.1905) should provide some decent support and the balance of risks look skewed to another move north of €1.20 in coming weeks.
GBP/USD
Sterling has had a superb run against the US dollar, bouncing well off its lows of $1.5250 to trade six cents higher. As evidenced by stronger stocks in January (an historically strong month for equities), risk appetite has been fairly prominent in recent weeks, which has weakened the US dollar considerably. As usual, GBP/USD has tracked a considerable rebound in the EUR/USD pairing, which we don’t see lasting too much longer.
The US Federal Reserve’s announcement that it expects to keep interest rates at record lows close to zero until late 2014 has done the US dollar few favours by fuelling risk appetite. Likewise the greenback’s strange relationship with US economic data has swung out of its favour. The encouraging signs out of the US economy, as evidenced by the lowest unemployment levels in three years, have added to the prevailing risk-friendly environment.
However, once market sentiment sours as a result of the eurozone crisis (as it inevitably will do) and investors flood back into safe-havens as we anticipate, then the robust figures coming out of the US economy should work in the dollar’s favour again.
GBP/USD’s rally looks to have some more legs in the short-term, which could see the $1.60 level tested. Beyond this though, we see the rate coming back down (perhaps quite aggressively) towards $1.55, in line with our bearish view for the EUR/USD pair.
Caxton FX one month forecast:
GBP / EUR 1.21
GBP / USD 1.5750
EUR / USD 1.3050
Richard Driver
Analyst – Caxton FX
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