It was a case of more
of the same for the pound in February; it posted fresh multi-month and multi-year
lows against a host of currencies. Domestic growth data has consistently
disappointed and as a result there has been a significant shift in rhetoric
from the Bank of England, which is sounding more dovish than ever. The Monetary
Policy Committee looks highly likely to set aside concerns over the UK’s higher
inflation outlook and focus once again on kick-starting the recovery with
further quantitative easing, perhaps as soon as this month. With UK data
unlikely to inspire much confidence in the weeks ahead and Moody’s having
finally downgraded the UK’s AAA credit rating, there is little domestic news
that seems likely to come to GBP’s support. However, to an extent all the bad
news is out in the open as far as sterling is concerned, which really isn’t the
case with other currencies like the euro.
As seen in the aftermath of the recent worrying Italian
election result, sterling will still benefit from rising demand amid periods of
eurozone panic. This really is likely to prove the key if sterling is to turn
its fortunes around because when market sentiment is stable and risk appetite
is in play, GBP looks in poor shape. Given recent developments, it won’t come
as much of a surprise that Italy is likely to be the focal point of eurozone
tensions in the coming weeks and months.
We are some way from knowing whether an Italian coalition
government can be formed, or whether a fresh election will have to be called.
Neither scenario is likely to produce a very convincing end-result in terms of
maintaining Italy’s commitment to economic reform, so we could well be entering
a fairly lengthy period of market uncertainty. This should at halt GBP/EUR’s
decline and could yet instil sufficient euro-negativity to trigger a sustained
bounce.
GBP/EUR
GBP/EUR finally stops the rot
The pound’s dire start to 2013 continued in February, amid
negative economic news, rating agency action and ultra-dovish commentary from
our friends in the Monetary Policy Committee. Taking a look at the economic
data to begin with, the UK PMI figures have far from eased concerns. A weak set
of January figures was put down largely to the impact of the snowy weather.
However, February’s manufacturing and construction updates were shockingly poor
and hopes are not high for tomorrow morning’s services figure.
Moody’s finally wielded its axe in the direction of the UK’s
AAA credit rating, the result of which was a two cent knee-jerk lower (though
this was quickly recovered). We shouldn’t have to wait too long (perhaps a
couple of months or so) before Fitch and S&P have followed suit but this
doesn’t pose much of a threat to sterling in our view. The first move was
always likely to be the most damaging and even this didn’t produce a sustained
sell-off – the news will now be fully priced in. George Osborne seems set to
stick to his guns with respect to austerity, though more details will emerge in
this regard when he delivers his March 20th Spring Budget.
More QE likely from MPC
On the monetary policy front, we have an extremely
interesting week ahead. The MPC meets on Thursday and we are now expecting a
majority decision in favour of quantitative easing. The shift in dovish
rhetoric has been pretty drastic in recent weeks. First of all and
significantly, last month’s MPC meeting minutes revealed that Mervyn King and
Paul Fisher voted in favour of more QE in addition to the previously lone dove
David Miles. In his ten years in office as Governor of the Bank of England,
only four times has King been in the minority and each time he has found
himself in the majority soon after, such is his influence. We expect the same
to be true this time.
Last month’s UK inflation report downgraded economic growth
prospects and recent data has been surprisingly weak, which suggests now is the
time for emergency action. In addition, there has been plenty of rhetoric with
respect to a more flexible approach to UK inflation. In other words, the MPC
has made its peace with the fact that UK inflation will be well above target
for the next three years but boosting UK growth is more important. This means
more QE. If the MPC do not decide in favour of QE this week, we’d be surprised if
we had to wait beyond May.
Italian elections shake the markets
From the eurozone, Italy has finally given the market reason
to pause and question whether the euro really should be the ‘hot pick’ that it has
represented over the past six months. A messy election result has produced more
questions than answers as to what is next in terms of Italian government. Bersani’s
Democratic Party failed to secure a parliamentary majority with Berlusconi’s
centre-right coalition making a late surge into second place. Meanwhile, comedian-turned-politician
Grillo’s anti-austerity 5 Star Movement came in third, which shows what Italy
thought of Monti’s pro-austerity tenure.
Both Berlusconi and Grillo achieved blocking minorities in
the Senate. Bersani has rejected the most obvious path of a grand coalition between
his party and Berlusconi’s, while Grillo has ruled out offering Bersani his
support. Bersani seems intent on forming a government on his own but the
chances of another election later on this year look very high indeed now. The
bottom line is that Italian efforts towards economic reform and debt-reduction
will likely fall back, which should see pressure in the bond markets rise in
the months ahead.
On the data front, actual eurozone growth indicators have
failed to track improvements in confidence figures. Sentiment gauges out of
Germany have been very encouraging indeed but manufacturing and services growth
data from the powerhouse economy were disappointing in February, as they were
from France and the eurozone as a whole. As shown by this week’s poor eurozone consumer
confidence figure, concerns over Italy are likely to weigh for some time now. On
top of these weak Q1 figures, data confirmed that almost all eurozone nations
contracted at a sharper rate than expected in Q4 2012 – Germany included. Eurozone
growth will clearly remain a concern for the European Central Bank but we do
not expect an interest rate cut for at least the next few months, though the
risks of a cut this year are rising with every month of economic contraction.
There remains a host of other eurozone concerns, from Cyprus’
bailout needs to Portugal’s demands for a renegotiation of its bailout terms,
and plenty more besides. Regardless, sterling is seeing a diminished share of
the safe-haven flows. Sentiment towards the UK economy remains extremely and
unsurprisingly weak, which means we cannot discount another test of February’s
lows around €1.1350 in the short-term. On balance, we would expect those lows
to hold firm and for this pair to avoid any further major declines in the
coming month. In fact, another visit to the €1.1835 high we saw a month ago is
still a very realistic target once the dust has settled on this week’s weak UK growth
figures and probable QE top-up.
GBP/USD
Greenback still on the up
This pair’s February and year-to-date charts are very ugly
indeed as far as sterling sellers are concerned. Growth data has been very disappointing
and we cannot discount a triple-dip recession. Moody’s downgraded the UK’s
triple-A credit rating and the MPC has been particularly dovish, to which the market
has responded by pricing in a pro-QE decision this Thursday.
Meanwhile, the US dollar has been very dominant indeed right
across the board, not just against the pound. Firstly, there was positive economic
news in the form an upward revision to the initial US GDP figure for Q4, which
indicated a contraction. Some meagre growth has now been reported from a rather
stagnant end to 2012, which was dominated by concerns over the US fiscal cliff.
Data from the US in February remained on an uptrend by and large; consumer
sentiment, housing data and manufacturing growth provided some highlights. There
are well-placed hopes for a firm rebound in Q1.
Bernanke remains dovish on QE3
What the market is perpetually concerned with is what implications
this firmer data has on the future of the Fed’s QE3 programme. Judging by
Bernanke’s recent semi-annual testimony before the US House of Representatives,
a move to taper QE3 off is not imminent. However, there remains significant support
from within the Fed to do so and we expect that as the US recovery continues
and uncertainty surrounding US fiscal policy fades, QE3 can begin to be wound
down in the second half of this year. If so, this will be very good news for
the dollar.
A reversal of the EUR/USD pair’s Q4 2012 rally has been a major
weight on the GBP/USD, as was always likely. We expect the euro to lose further
ground below $1.30 against the greenback, which should contribute to further
pressure on GBP/USD in the coming weeks. There is scope for a bounce back up to
the $1.5150 area but really we are expecting to see a sustained move below the $1.50
benchmark in the next few weeks.
Richard Driver
Currency Analyst
Caxton FX
