Sterling to benefit
from resurgent UK economy
From the eurozone, September’s two
key events were ECB President Draghi’s announcement of his long-awaited
bond-buying plan and the German Constitutional Court’s decision to approve the
permanent bailout fund. Since then, there has been a real lack of any further
concrete developments, which has understandably frustrated many market players
and caused some risk aversion. As the next major event in the timeline of the
eurozone debt crisis, speculation over the imminence of a Spanish bailout request
is dominating market thinking at present. PM Rajoy does not actually appear to
be much closer to making a formal request; he looks likely to wait until after
Spanish regional elections to be held on October 21.
From the US, we have finally seen Ben
Bernanke deliver what the market has been waiting for – more support for the US
economy in the form of QE3. The move was priced in to a large extent but the dollar
has been unable to stage any significant recovery in the immediate aftermath of
the Fed’s announcement.
Conditions here in the UK continue
to look a little brighter, though understandably many investors will still need
further positive evidence to be truly convinced that the economy is on a path
to a sustained recovery. However, with the Japanese and US central banks
engaging in QE in September and the European Central Bank also taking monetary
easing measures of its own (though rather more unconventional), the market is
beginning to look more favourably upon the pound again.
GBP/EUR
Spanish delays will
hurt the euro
Sterling has made a decent recovery
against the euro in recent weeks, after what was quite a sharp decline as a result
of the optimism that followed the announcement of the ECB’s bond-buying plan. There
has been a positive response to some of the UK figures that have emerged in
recent weeks; trade balance data revealed a dramatic rise in exports to
destinations outside the EU, suggesting UK businesses are adapting to deteriorating
eurozone demand. Meanwhile, UK unemployment figures continue to defy the
overall weak picture of UK economic growth by making significant strides. From
retail sales data to public sector borrowing figures, the UK economy has been
beating market expectations time and again and this is filtering into some
sterling strength. Another positive has emerged with the latest upward revision
to the UK’s Q2 GDP figure to -0.4%, considerably better than the original
estimate of -0.7%. Hopes are high for a very strong showing for the Q3 UK GDP
figure released on October 26.
The minutes from the MPC’S
September meeting revealed a unanimous vote against further QE (for now). The
decision in favour of leaving the BoE 0.5% base rate unchanged was also
unanimous. The fact that one MPC policymaker saw a good case for QE in
September did not go unnoticed but as things stand, the Bank of England is understandably
in wait-and-see mode. In light of the increased room for domestic optimism and
the easing of financial conditions in the eurozone in recent weeks, it will not
come as much of a surprise to learn that we are not expecting any fresh
monetary easing measures from the Bank of England this month. November is
likely to see the Bank assess its options much more carefully though.
Coinciding with strong economic
figures has been an increased appetite for the pound as a relative safe-haven.
Gilt yields have declined in recent sessions as investors attempt to take cover
from renewed uncertainties from the eurozone and as usual this has boosted the
pound by association. With the QE decisions from the US Federal Reserve and the
Bank of Japan in September, sterling has climbed a little higher up many
investors’ wish lists in recent weeks.
Putting improved UK conditions to
one side, the major factor behind GBP/EUR’s climb in the past month has been a
shift in sentiment against the euro, as is predominantly the case when this
pair climbs. The market relief that followed the ECB’s commitment to buy
unlimited quantities of distressed peripheral debt has well and truly worn off.
Investors have refocused on the major issues facing Spain and Greece in
particular.
PM Rajoy has thus far snubbed the
opportunity to take advantage of the ECB’s offer to purchase Spanish debt,
fully aware of the austerity demands that will accompany such intervention.
Rajoy is under enormous pressure domestically, with the rich Catalonia region
demanding independence and fierce protests taking place in Madrid over existing
austerity measures. The market is likely to have to wait until after regional
elections held on October 21 for Rajoy to bite the bullet, which leaves a good
three weeks of frustration ahead. That said, if rating agency Moody’s cuts
Spain’s credit rating to ‘junk’ status, then a spike in Spanish bond yields
could force Rajoy’s hand a little sooner.
Greek saga remains
volatile
The situation in Greece also
remains typically uncertain. October is an important month too, with some
chunky bond repayments maturing. Disagreements not only exist between Greece
and the Troika (EU, ECB and IMF) but between the IMF and the EU. With the Greek
debt profile blown even further off track by a deeper than expected recession,
the IMF is now pushing for another Greek debt restructuring in order to get its
debt sustainability back on track. Unsurprisingly, more ‘haircuts’ is not at
the top of the EU’s list of priorities.
It looks as if there is some
consensus over giving Greece an additional two years to meet its targets and the
government appears to have been reached an agreement for €13.5bn in additional
spending cuts that they hope will unlock the vital next tranche of aid.
However, the agreement still needs Troika approval and would need to be
approved by the Greek parliament, which amid violent public protests in Athens is
no dead cert. Speculation has surrounded the need for a third Greek bailout but
this option looks to be a non-starter as it would require parliamentary
approval from individual member states. The bottom line is that Greece may well
leave the eurozone but EU leaders are unlikely to let this happen while conditions
in Spain remain so tense. The pressure for stronger signs of progress will be
turned up once again at the next EU Summit on October 18-19.
Sterling has recouped its
mid-September losses against the euro and is back trading above the €1.25
level. With market confidence so shaky at present, any concrete progress - most
importantly from Spain in the form of a bailout request – will likely give the
euro a significant lift. However, our baseline scenario is that this will not
occur and that sentiment will continue to weaken towards the euro, helping sterling
to build on its domestic economic resurgence and resume its uptrend against the
euro.
GBP/USD
Dollar to strengthen
despite QE3
The US
Federal Reserve finally pulled the trigger on QE3 in September, which meant it
was another very soft month for the US dollar. There have been some bright
spots amongst US figures in the past month, with trade balance, retail sales
and consumer confidence figures all showing some improvements. However, there
has been plenty of evidence of continued economic weakness to support Ben
Bernanke’s decision to turn the printing presses back on; last month’s key employment
update gave little to cheer about. In addition, the final US GDP figure for Q2
was sharply and unexpectedly revised down to 1.3% from 1.7%.
The issues of weak US economic
growth and a long period of quantitative easing are by no means at the top of
most investors’ list of concerns. The US dollar has strengthened a little in
the past fortnight, amid waning euphoria surrounding the QE3 announcement and
the ECB’s pledge to purchase peripheral debt. Spain has not asked for a
bailout, Greece has not secured its next tranche of aid and growth across the
world is slowing. These are all dollar-friendly factors and the slowdowns being
seen in China and the eurozone (including Germany) are of particular concern.
Whilst UK growth data has been
remarkably positive in recent weeks, the ongoing fragility of the UK recovery
has already been highlighted this week by a weaker than expected manufacturing
figure. If sterling is to avoid another short-term sell-off against the US
dollar, the UK services figure released on October 3 must be firm. However, sterling
should get plenty of support in the form of the preliminary Q3 UK GDP figure
released on October 26; we are looking for a robust quarterly showing of around
+0.6%.
As things stand, sterling is
trading almost two cents below September’s 13-month high of $1.63 and we think
this high will remain a ceiling for this pair. Regardless of QE3, we see plenty
of scope for increased demand for the safe-haven US dollar. We are still
anticipating weakness in the EUR/USD pair, which should send GBP/USD back below
$1.60 in October.
Richard Driver
Currency Analyst
Caxton FX
