The euro-bashing continues amid delays to the German court ruling
The euro has hit fresh lows against the dollar and the pound in the past week thanks to further declines in US stocks, widening peripheral bond yields and heightened eurozone concerns.
Germany’s constitutional court has decided to wait until September to give its ruling on whether the changes to the European Stability Mechanism and the fiscal compact are legal according to German law. This sets back the implementation of the progress made at the EU’s last Summit and ensures a high degree of market uncertainty over the rest of the summer. The decision goes against the pleas from the German government for a swift ruling that would help contain the debt crisis.
ECB President Draghi has tried to calm market tensions, asserting last week that the euro as currency was irreversible, but investors failed to take much comfort. The euro has been unjustifiably high over the past two years given its waning economic fundamentals and soaring debt levels; the euro’s sell-off since early May is the correction that we have had to be very patient in waiting for.
Bank of England ‘Funding for Lending’ scheme impresses
Sterling is benefitting from plenty of safe-haven flows at present, which has seen GBP/EUR hit a fresh 3 ½ month high of €1.2768. There have even been some small pockets of optimism in the UK economy of late; industrial and manufacturing production growth improved in May thanks to shifting the Bank Holiday to June. The UK trade deficit even narrowed significantly in May. Last Friday saw the release of details relating to the Bank of England’s new ‘Funding for Lending’ scheme. UK banks will have access to £80bn worth of cheap loans and will be incentivized to pass this on to UK businesses. The markets responded positively to the programme, which starts in August, and sterling performed strongly. Nevertheless, the market will not kid itself into thinking the UK economy is going to gain much momentum in H2 of 2012.
UK inflation has come right down to a 34-month low of 2.4%, driven by weak domestic activity but this also been helped by the stronger pound. Low inflation clearly supports the MPC’s decision earlier this month to introduce further QE. The minutes from that meeting will be released on Wednesday morning and a unanimous vote in favour of QE could possibly be revealed, at least a strong majority. This shouldn’t weigh on sterling too heavily. UK retail sales data for June should again be positive on Thursday, helped by the Queen’s Diamond Jubilee celebrations.
US Federal Reserve Chairman Bernanke speaks again over the next two days and with data revealing on Monday that US retail sales contracted sharply once again in June, hopes are high for indications that QE3 is imminent. Despite ongoing weakness in US figures, we expect yet more of the same from Bernanke, a dovish tone but reluctance to signal QE3 for the time being.
Sterling is trading at €1.2720 today and continues to look poised for another push higher. The euro’s sell-off looks set to drag on further, particularly in light of the German constitutional court’s decision to delay its decision. At $1.56, sterling is performing strongly against the USD but we don’t see this lasting much longer. EUR/USD should weigh on the GBP/USD but we still see the pound holding up better than the euro.
End of week forecast
GBP / EUR 1.2775
GBP / USD 1.5550
EUR / USD 1.2175
GBP / AUD 1.5275
Richard Driver
Analyst – Caxton FX
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