July was certainly a better month for sterling, taking advantage of struggling commodity currencies such as the aussie and kiwi. This was a result of a number of factors including better than expected data releases. The release of the BoE Inflation Report revealed forward guidance explaining that the outlook of interest rates will be linked to unemployment and inflation and that when ‘knock out’ conditions are breached, the monetary policy committee will have reconsider their stance on interest rates. Meanwhile the BoE minutes showed that MPC member Martin Weale voted against forward guidance because of the risk of rising inflation breaching the main goal of price stability. Upward revisions to the UK GDP reading has worked in the pound’s favour as well as strong PMI data also supporting the pounds uptrend.
The dollar on the other hand has begun to regain ground against major counterparts and the case of QE3 tapering rambles on. With September now underway, tension continues to build as to whether economic fundamentals provide enough reason for the Fed to reduce stimulus as soon as this month. Some economic releases such as Preliminary UoM consumer sentiment and new home sales did prove to be disappointing while housing data signals that unemployment is heading in the right direction. Nevertheless, the overall perception of the US economy remains fairly positive and speculation on whether the Fed will announce the beginning of tapering on September 18 remains.
The euro has been the bright spark recently with economic fundamentals surpassing expectations and boosting the views that maybe the eurozone recession is bottoming out. GDP figures have shown Q2 growth for the euroarea which has boosted investor confidence and encouraged EUR strength. Figures out of Germany have also favoured the euro and are becoming more and more like the glue holding the eurozone together. There is still plenty of worrying news out of the Euro area including high unemployment and the Greek funding gap issues which may present themselves as an increasing concern.
GBP/EUR
The UK economy is beginning to look much more stable than previously thought and the positive stream of UK data has worked in the pounds favour broadly speaking. The release of the Inflation Report and Bank of England policy meeting minutes provided the market with some clarity through forward guidance, which aimed to outline the direction of future interest rates.
The month of August saw the UK Service PMI figure jump to 60.2 and both manufacturing and industrial production exceeded estimates at 1.9%m/m and 1.1%m/m respectively. The good news continued through the month as the trade deficit narrowed to £8.1bn and inflation slowed to 2.8%. The upward revision to the Q2 GDP reading confirmed that recent positive stream of data was being reflected in improved UK output. Second quarter GDP was revised up to 0.7%qoq. The Confederation of British Industry raised their forecasts for expected GDP growth this year further supporting the view that the UK recovery is strengthening. CBI Industrial order expectations smashed predictions signalling businesses are more confident about the progress of the economy and are subsequently acting on it. Although the 0 figure doesn’t exactly scream an increasing order volume, it doesn’t signal a reduction in order volume either, and is therefore a step in the right direction.
The Bank of England Governor Mark Carney outlined in the Inflation Report that future interest rates will remain low until unemployment is at 7% which is expected in 2016. Initially this was taken pretty well by the market as it simply outlined what the market expected. However as UK data continued to impress, the likelihood that the unemployment rate will fall to 7% before the 2016 estimate increased resulting in upward pressure on the interest rate. The monetary policy meeting minutes revealed that committee member Martin Weale was against forward guidance on worries about the effect on inflation, proposing that a shorter timeline for considering rates would ensure price stability. This fuelled doubt about whether the Governor can actually ensure rates will remain at 0.5% with yields pushing higher, potentially threatening the recovery. In Carney’s first speech, the aim was to convince the market that he would be able to keep rates low until 2016 as expressed through forward guidance. This was partly successful in the sense that he reiterated the committee’s commitment to sustainable UK growth, revealing that the BoE may provide extra stimulus if the UK recovery is being threatened by rising market rates. On the other hand, with gilt yields rising on the back of his comments, it can be argued that he didn’t manage to achieve the objective of combat higher market rates. Investors seem to still believe that with the way the economy is going, a rate hike may be seen sooner and with inflation still well above the target at 2.8% it is understandable why.
The euro begins to get back on its feet
Better Eurozone fundamentals have seen the euro take control of this pair towards the end of last month, while good economic figures from the UK have been overshadowed. The first important signal came from Italy when its preliminary GDP reading showed the recession eased, contracting 0.2% q/q. Other fundamentals such as German, French and Eurozone GDP figures beat expectations, promoting confidence in the Euro area. PMI figures for Germany and the Eurozone were received well despite a disappointing figure from France.
Other German data releases such as the German IFO data and German ZEW Economic Sentiment came in above expectations boosting perceptions about the state of the German recovery and ultimately euro zone progress. Encouraging releases have fuelled suggestions that the positive movement in the EUR has been a result of German figures rather than an overall improvement in the region.
Problems in the Eurozone are persistent especially in Greece. It was revealed that the country will need another bailout after its current package is due to expire next year. The IMF has put the combined figure needed for Greece at €11.1bn for 2014 and 2015. Unemployment remains an issue throughout the eurozone, with Greek unemployment hitting 27.6% and the IMF sending Spain a warning about their unemployment rate currently at 26.3%. Imbalances within the area are evident as the German manufacturing and service sectors expanded while the French contracted.
After broadly trending upwards for most of August, we are likely to see the GBPEUR trend repeat itself next month. Despite the Eurozone showing sparks of improvement, the overall outlook for the UK is outpacing that of the eurozone. This week sees monetary policy announcements from both the BoE and ECB and although no rate changes are expected, the market will be drawn to the central banks’ comments on the state of both economies. We expect the GBPEUR rate to improve gradually from its current levels even though a dovish Carney and over optimistic euro investors could limit sterling gains.
GBP/USD
Speculation on Fed tapering rambles on
During August there has been a considerable amount of evidence supporting the Fed case for reducing its asset purchasing program. Data has been mostly positive indicating that US growth is stable and the economy is picking up pace.
A number of Fed members have made statements claiming that the Fed’s decision to reduce stimulus will be dependent on the outlook of the US economy. As a result, investors have been eyeballing US data looking for signs on the strength of the recovery. Better than expected data releases such as ISM- non manufacturing PMI data and core retail sales have steered the market into predicting a reduction in stimulus. There has been some disappointing figures such as Preliminary UoM consumer sentiment as well as new home sales which provided doubts as to whether it is wise for the Fed to take their foot off the stimulus pedal however, data still suggest there are enough positive signals to assume tapering will take place this year.
Preliminary GDP figures which showed US output accelerated by 2.5% (consensus of 2.2%) simply brightened the US outlook and has triggered some dollar movement to the upside. Considering speculation has been on-going, the GBPUSD rate has been fairly resistant gradually rising through the most of August. As the case for tapering continues to build, we have begun to see a reversal, with the month end showing the beginning of a downward trend.
Whilst we expect data to continue to fan the tapering flame towards the end of this year, the market will be looking forward to the Fed rate announcement on September the 18th, which will indicate clearly whether we can expect tapering to begin as soon as this month. The possibility remains that the central bank may hold off this month, as a result of the mixed messages sent by recent data releases. Nevertheless, the fact remains that dependent on the outcome of economic fundamentals, tapering is still very much a possibility as we approach year end. Mixed data releases may prompt the Fed reduce stimulus at a slower rate ranging between $5bn- $10bn until the recovery becomes self sustainable. Good releases from the UK and optimism about the outlook will attempt to prevent the dollar rising, yet with the effects of possible tapering and a dovish Carney, it is unlikely that the pound will be able to withstand dollar gains, in spite of recent upward movement. Therefore we believe the downwards trend we have witnessed of late will continue though the month.
GBP/EUR: €1.18
GBP/USD: $1.54
EUR/USD: $1.31
Sasha Nugent
Currency Analyst
Caxton FX
