February 2013 Corporate Report: Sterling friendless
January was another rough month for the pound, against
almost every major currency, and the coming weeks do not look likely to be
particularly fertile for a recovery. Sterling has been among the poorest
performing currencies in the market, with a wide range of concerns over the UK
economy weighing heavily. There are risks of a triple-dip UK recession, which
in turn raise the probability of further quantitative easing from the Bank of
England and a loss of the UK’s AAA credit rating. Until UK growth shows some signs
of a recovery, the pound is likely to remain under pressure.
The euro’s remarkable rally continued in January, helped by further
market calm in the eurozone and subsequent improvements to global market
sentiment. ECB President Draghi gave the euro plenty of support by quashing
speculation that his central bank would opt to cut interest rates (watch out
tomorrow for further rhetoric). This optimistic approach has actually been
bolstered by significant improvements to German economic data, even if growth
in Italy, Spain and France remains very weak indeed. It only takes one look at
bond yields in Italy and Spain to realise that nerves towards the debt crisis
are at a low ebb and that confidence is pretty stable. That said, the past week
has seen tensions rise ahead of Italy’s election this month.
Other than against the euro, the US dollar is also in pretty
good shape. However, the recent weak US GDP figure for Q4 2012 hasn’t done the
greenback any favours and will play into the hands of Ben Bernanke and the
other dovish leaning policymakers within the US Federal Reserve. Positive
sentiment towards the euro looks likely to limit the dollar’s gains in the
coming weeks, but we still expect the USD to have a strong 2013.
GBP/EUR
Triple-dip fears dog the pound
Sterling is hugely out of favour at present; depreciation
was so drastic in January that sterling’s trade-weighted index dropped by the
most since February 2010. Economic weakness, speculation of more UK monetary
easing and a more general loss of faith in the GBP as a safe-haven are all
issues which have weighed heavily. The warnings as to a UK debt downgrade have
been understandable and whilst predicting the timing of a downgrade is tricky,
it would surprise us if the move was delayed beyond June.
Does sterling really deserve the battering it has received?
Well, it certainly deserved some punishment; negative growth and a lack of
progress on the UK’s debt situation are always issues likely to make themselves
felt on the exchange rates.
There remain some brighter spots within the UK economy; the
Funding for Lending Scheme appears to be bearing some fruit - bank lending is
on an uptrend. The UK labour market continues to defy the wider domestic
downturn. However, these rare good news stories have been of little use to
sterling, with investors questioning how positive these factors can really be
if they are not resulting in any genuine economic growth.
Unfortunately it’s quite clear that it will not be a
particularly robust start to 2013, thanks to January’s snowy weather. The truth
is that last summer’s Olympics concealed very weak underlying growth, which
will become even more apparent over the rest of Q1. Sterling has at least been
granted the relief that the UK services sector returned to growth in January
but the risks of a triple-dip recession are still finely balanced.
Despite weak growth, we do not expect the Bank of England to
opt for another dose of quantitative easing at its February meeting on
Thursday, with most members satisfied with the Funding for Lending Scheme as an
alternative to QE. David Miles is likely to remain the only voter in favour of
QE in the February 7th meeting; we expect the MPC under Sir Mervyn
King to continue opting against further easing.
What will be more interesting on February 7th will
be Mark Carney’s appearance in front of the Treasury Select Committee. The
market will be watching very closely for clues as to how Carney, who will take
over from King as BoE Governor on July 1st, will approach monetary
policy. Unlike King’s comparatively hawkish doubts over the efficacy of more
QE, Carney has been vocal on the utility of further easing and has pointed to
other “unconventional instruments” which suggests he will strike a more dovish
tone on Thursday. This is unlikely to be good news for the pound.
Germany perks up to help the euro
Once again, it’s been fairly quiet on the eurozone front,
which has been a major factor behind the ongoing gains being made by the euro
across the board. The weak investor sentiment towards the eurozone that
characterised so much of 2012 is being unwound, as the risks of a eurozone
break-up recede.
German data has been particularly encouraging in recent
weeks with forward-looking sentiment and confidence surveys hitting multi-month
highs. Still, the PMIs out of the eurozone as a whole continue to point to
further economic contraction, which should lead to euro-weakness later on in
the year. However, at present the market appears content to overlook awful
growth and celebrate the signs that the worst of the debt crisis is behind us. This
is really why GBP/EUR’s decline has been so aggressive.
There is evidence of burgeoning political tensions in the
eurozone. Italy’s elections are scheduled for February 24-25 and considerable
uncertainty lingers with respect to the outcome, particularly with the latest
polls suggesting that Berlusconi is closing the gap. In addition, there is
scope for Berlusconi’s PdL party to block the governing coalition’s laws in the
upper house. Elsewhere, there are calls for Spanish PM Rajoy to resign after
having been embroiled in a corruption scandal. This could potentially derail
Spain’s reform programme and damage the stability we have seen in peripheral
bond yields.
On the monetary policy front, ECB President Draghi has been
very helpful to the euro, sending strong signals that he will not elect to cut
interest rates once again, regardless of weak eurozone growth and record-high
unemployment. Also propping up the euro has been Draghi’s refusal to express
concern at the euro’s impressive rally to 15-month highs against the pound and
US dollar. Euro bears will be watching this Thursday’s press conference very
Draghi closely for signs that he is uncomfortable with the euro at current
levels. We suspect they may be disappointed.
Sterling has depreciated by around 6.0% from where it
started the year (marginally above €1.23). Amid the ongoing anti-sterling
sentiment that is still simmering away, we don’t expect that this pair’s trough
of €1.1470 will be as low as it goes. If Draghi sounds in confident mood on
Thursday, we’d expect the downside to be tested once again in the coming weeks,
with significant risks of a move down to €1.1364 (88p). However, we do expect
this pair to bottom out soon and remain confident of a sterling recovery
thereafter.
GBP/USD
Dollar flexes its muscles despite stalling
US growth
The news out of the US economy has been typically mixed over
recent weeks and there was no real change in stance from Ben Bernanke and the
US Federal Reserve as a result. The fourth quarter US GDP figure for 2012 actually
confirmed a surprise 0.1% contraction, rather than the modest 1.1% growth that
was expected. In addition, the US unemployment rate jumped back up to 7.9%,
which considering Bernanke’s obsession with bringing the jobless rate right
down before ending QE3, was not good news for the US dollar.
The market has been correct not to panic at the US economy’s
weakness at the end of last year, much of which can be put down to the effects
of Hurricane Sandy. The Fed was clear that it was a case of growth pausing as
opposed to it representing the beginning of another dip back into recession.
The GBP/USD pair’s sharp decline in the year to date has
finally started to reflect the contrasting conditions and outlooks for the UK
and US economies. Whilst the US has suffered some temporary weakness,
underlying growth is still in decent shape and this will continue to be the
case in 2013. The UK, by contrast, did not grow in 2012 and will struggle to
eke out much growth in 2013.
An interesting theme over recent weeks has been the US
dollar’s strong performance against currencies like the GBP, despite its
extreme weakness against the EUR (EUR/USD climbed to a 15-month high only last
week). We are already seeing concerns over the political situation in Spain and
Italy spark doubts over how much higher EUR/USD can go. If we see the downward
correction in EUR/USD that we continue to expect, then we expect GBP/USD to
suffer as a result. Sterling is struggling with weak domestic news as it is,
without major euro-dollar flows adding further pressure. This may well be
delayed until later on in the year but it would be no real surprise if it came
sooner.
We may see GBP make another attempt above the $1.57 level in
February but we expect that would represent an attractive level at which to
sell. This should signal another move lower and potentially take this pair to
fresh 6-month lows below the recently hit $1.5650 level.
GBP/EUR: €1.14
GBP/USD: $1.55
EUR/USD: $1.3650
