The pound dominated trading last month and economic figures continued to support the brighter outlook for the UK economy. This may all change this month as the BoE release their Inflation Report and express worries about sterling’s recent strength. We may also see investors begin to profit take as the market questions the pound’s recent performance.
We have got a little closer to identifying what may be in store from the ECB. At the WEF in Davos, ECB President Draghi reinforced his view that deflation is not on the horizon for the euro area, and also claimed the central bank stand ready to fight against such pressures. This should keep the euro fairly supported although tighter conditions in the money markets will keep the pressure on.
After beginning their tapering programme in December, the Fed decided to reduce asset purchases further by another $10bn. Ben Bernanke definitely seems to have gotten the ball rolling with regards to withdrawing stimulus, but whether his successor Janet Yellen will keep this up is the question. Janet Yellen is regarded as a dove, and this may be reflected in her views of the economy going forward.
The BoE lines up more talk to weaken the pound
In recent weeks, BoE Governor Carney has displayed some concern about the strength of the pound. Most of sterling’s momentum is due to economic figures which have displayed a much healthier economy. The latest unemployment figure showed the jobless rate fell to 7.1% (the lowest level since the first quarter of 2009) and this has brought in to question where forward guidance will head now. In their last monetary policy meeting minutes the central bank saw no need to raise interest rates just yet, and this suggests that the bank are in no rush to tighten monetary policy even after the 7% threshold has been breached. At the WEF in Davos the Governor said that forward guidance will no longer be linked to just the unemployment rate, but rather a range of factors that reflect the overall state of the economy.
The latest GDP reading showed that the economy grew by 1.9% in 2013, the strongest level since 2007. Although this is an encouraging number, the latest labour market figures revealed that total hours worked grew by 1.1% meaning that output per working has fallen. These numbers highlight the issue with slack and productivity and it is likely we will see more focus on this in the weeks ahead.
GBP/EUR
A little insight into what may be in store from President Draghi.
Eurozone figures have shown some improvement over the last few weeks, especially PMI data which the market responded to well. Ireland has made a smooth exit from its bailout plan whilst Portugal looks on track to do the same. Despite some optimism brewing in the Eurozone, sterling still remains firmly in
control of the GBP/EUR as global deflation is a main concern especially in the Eurozone. At the WEF, ECB President Draghi explained that he does not see deflation in the Eurozone but rather a prolonged period
of low inflation. This language is similar to what we have heard from the central bank in the past few months but the surprise drop in inflation back to 0.7% y/y has kept the pressure on the ECB. More importantly,
Draghi explained that quantitative easing – an option adopted by both the Fed and BoE- was not on the table as the European Union treaty “prohibits monetary financing”. In order to combat the lack of lending in the euro area, Draghi said he favoured another approach which involved the ECB buying packaged loans.
The ECB will meet this week and announce their interest rates decision. Considering the bank’s views regarding inflation expectations and price stability, it is unlikely that we will see any change in policy. With regards to inflation, focus remains firmly on price stability and it is clear that downside risks need to materialise in order to see further easing from the ECB. Nevertheless, the market will be watching closely for any change in rhetoric from the central bank.
GBPUSD
Another taper from the Fed, and dollar momentum gets underway
In Ben Bernanke’s last FOMC meeting another $10bn of stimulus was removed from the asset purchase program thanks to a unanimous vote. A further reduction in stimulus has negative effects for emerging markets, yet no attention was drawn to the recent chaos which resulted in a number of central banks having to raise interest rates. The decision also suggests that the central bank is optimistic about growth and is not fazed by the last employment report. This result was widely expected and after months
of sterling directing the rate higher, we may be seeing the beginning of a downward trend in this pairing.
The last nonfarm payroll figure came in well below estimates, whilst the unemployment rate dropped from 7.0% to 6.7%. On the surface, the jobless rate may seem encouraging, but the fall was due to a reduction in the labour participation rate which declined to 62.8%, the lowest level since 1978. This is a medium-to-long term concern which could dampen the view of the labour market. Friday’s release will be just as important as the last, and two consecutive poor readings will bring the Fed’s decision to taper into question.
We expect the pound will weaken in the course of this month as remarks from the BoE weigh on the currency. This leaves the ball in the dollar’s court, and as long as the economic data supports an improving
economy, the downward trend in GBP/USD should continue.
GBP/EUR- 1.2150
GBP/USD- 1.62
EUR/USD- 1.3380
Sasha Nugent
Currency Analyst
Caxton FX
