After some weak figures from the UK economy to kick October
off, we have enjoyed a pretty steady flow of positive domestic news. The highlight
has been the recent preliminary UK GDP figure for Q3, which indicated growth of
1.0%, almost doubling expectations. With headlines surrounding the UK economy’s
emergence from recession, sterling has enjoyed some renewed interest, though
with domestic growth so far this year almost completely flat, you don’t have to
look far to find the sceptics.
As far as the US economy is concerned, conditions are
certainly perking up. The recent advance US GDP figure for Q3 revealed annualised
growth of 2.0%, so it was a case of anything the UK can do, the US can do
better. The Fed will also be encouraged
by significant improvements in the US labour market. It appears that the recovery
of the world’s No.1 economy from its mid-year slump, albeit later than
expected, is well under way. Nonetheless, the risk of the US fiscal cliff
continues to pose serious threats to US and indeed global growth in 2013.
It has been fairly quiet on the eurozone front in recent
weeks. Spain remains frustratingly tight-lipped on the issue of a bailout
request. However, we are heading into a crucial week in which the Greek
parliament will decide whether or not to approve an austerity package that is
essential to the release of the country’s next tranche of aid.
GBP/EUR
Sterling benefits as
UK exits recession
Sterling spent much of October under pressure against the
euro, with no major panic headlines emerging out of the debt crisis. Disappointing
domestic data also kept sterling pinned well below the €1.25 level for long
periods, with the services, construction and manufacturing sector updates all
disappointing.
However, we have seen a decent turnaround in figures in the
past fortnight or so, which has provided sterling with renewed support. The
labour market continues to make impressive strides, as shown by the unexpected
dip in the UK unemployment rate to a 13-month low of 7.9%, while retail sales
were also in good shape in September. These figures were topped off by a 1.0%
preliminary UK GDP figure, which was well above the 0.6% estimates that were
prevailing in the build-up. With the data revealing that the negative growth
that dominated the first half of the year has been recouped, the UK government
enjoyed a rare sigh of relief.
MPC to vote against
QE this month
This all leaves the Bank of England interestingly poised in
terms of its next move. MPC members have been quick to warn that we can expect
a much weaker growth figure from the fourth quarter, once the temporary factors
of the Olympics and the bounce back from the extra Q2 Jubilee bank holiday are
discounted. However, judging by the minutes from last month’s MPC meeting, not
only is the MPC split on the desirability of another dose of quantitative
easing, but there appears to be plenty of scepticsm with respect to the
usefulness of such a move. In addition, there have been hints that the
government’s Funding for Lending initiative, where bank lending is
incentivised, is making a real difference.
There is plenty of reason to suspect that last quarter’s GDP
figure was a temporary surge for an economy that still needs nurturing back to
health. The latest updates from the services sector suggests the UK has made a
soft start to Q4 but we nevertheless expect the MPC doves to fail to muster a majority
vote in favour of QE this week.
Greece vote gets euro
nerves jangling again
As far as the euro is concerned, focus has centred on the
familiar issues of Greece, Spain and deteriorating eurozone growth. Greece will
dominate the eurozone headlines this week, with PM Samaras presenting a
controversial package of fresh austerity measures which will be voted on by the
Greek parliament later this week. The vote will come right down to the wire,
though we are expecting the package to be approved.
We are sticking to the ‘muddling through” assumption that
Greece will do what is demanded of it and in turn will receive some
concessions, along the lines of lower interest rates, extended loan maturities
and extended austerity deadlines. The stakes are simply too high to allow the
Greek saga to blow up again.
With Spanish bond yields coming away from the dangerous 7.0%
mark in the aftermath of ECB President Draghi’s pledge to buy up unlimited
peripheral debt, the pressure on PM Rajoy to request a bailout has eased
somewhat. However, the market is likely to take an increasingly dim view of
Rajoy’s ongoing procrastination through November (talk has emerged that he will
wait until next year). Ratings agency Moody’s handed Spain some breathing space
last month, sparing it the blow of downgrading its debt to ‘junk’ status but
there is little doubt it will wield its axe once again if progress fails to
emerge.
As ever, major concerns are stemming from the deteriorating
state of eurozone growth, as the region is dealt round after round of austerity.
Whilst the ECB now looks set to hold off from cutting interest rates until next
year, declining demand from peripheral eurozone nations continues to filter
into weakness in the eurozone’s core. German figures were yet again poor in
October, compounding fears that the powerhouse economy is heading into
recession. The region’s declining economy is really showing few bright spots,
while the headlines out of the UK economy contrastingly highlight its
re-emergence from recession.
Sterling is trading just below the key €1.25 (80p) level and
direction from here over the coming weeks will really depend on whether the
pound can make a sustained move north of this benchmark. We can’t discount
another move back down towards €1.23 but we maintain expectations for this pair
to move above €1.25 in the coming weeks.
GBP/USD
Dollar to benefit
from upturn in US growth
Sterling has traded very positively against the USD in
recent weeks but has finally suffered a downward correction in the past week.
GBP/USD is still only a couple of cents off April’s multi-month highs above
$1.62 with stronger UK data and diminishing risks of QE providing the pound
with plenty of support at $1.60, just when a move back down to the $1.50s has looked
on the cards.
The USD is attracting increased demand at present on the
back of some strong US economic figures. The US unemployment rate fell to 7.8%
in September, the lowest level seen in almost four years (though this bounced
up to 7.9% in October). The advance US GDP figure for the third quarter came in
above expectations at 2.0% (annualised), powered by a surge in consumer
spending and a temporary boost from defence spending. November’s excellent
employment update, suggests we can expect further improvements over Q4.
Global concerns to highlight
dollar’s safe-haven status
With the fiscal cliff a month closer, so too are the risks
of a massive hit to US growth. This in our view will increase appetite for the
safe-haven US dollar as we approach year-end. Meanwhile, we are struggling for
progress on the Spanish debt/growth problem and broader concerns with global
growth should also underpin the greenback.
Whilst the US Federal Reserve is engaging in QE3, the US
economy is still outpacing the UK by some distance and we believe this will
soon be reflected in some dollar strength. The UK’s last GDP figure may have
been impressive (1.0% in Q3) but looking at the year to date, growth has
essentially flat lined and with the eurozone recession deepening, major risks
to domestic growth remain.
This week’s US Presidential election makes short-term swings
highly probable and highly unpredictable. Not only is it unclear how the dollar
will react to whoever wins but there is also the issue of which party will
control Congress. Our conservative bet is that the status quo will broadly
remain, with Obama emerging victorious but with doubts remaining over his
ability to strike a deal to avert the fiscal cliff. We maintain our position
that that we will see this pair spend most of the rest of the year below $1.60.
Sterling’s two-month low of $1.5920 should be tested soon and we believe this
will ultimately be broken, paving the way for move back into the mid-$1.50s.
1-month Outlook
GBP/USD: 1.58
GBP/EUR: 1.2550
EUR/USD: 1.26
Richard Driver
Currency Analyst
Caxton FX
