Bank of Canada deals the loonie a blow

The Bank of Canada is ahead of almost every other developed nation central bank in terms of when it expects to normalise monetary policy (raise interest rates). The fact that it is even discussing it is your first clue, as conversations within central banks such as the Bank of England, Reserve Bank of Australia, the European Central Bank and the Riskbank are slanted towards rate cuts, not rate hikes. If it’s not rate cuts, then it’s more QE from the likes of the US Federal Reserve and the Bank of Japan, whose base rates are already at rock bottom levels.

Last year’s Bank of Canada rhetoric pointed towards a rate hike this year. However, the slowdown seen in the US at the end of 2012 has contributed to softer growth in its northern neighbour. Canadian growth has consistently surprised the BoC to the downside in the past year, particularly in the second half of 2012. Governor Carney (BoE-bound this summer) & Co yesterday indicated that the Canadian economy will not be up to full capacity until the second half of next year, which is a major delay compared to the previous ‘late 2013’ projection. Combined with subdued inflation and ongoing concerns over household imbalances, this has led the BoC to communicate that a rate hike is by no means imminent. It estimates a rate hike at the end of this year but our bet is that it will come a later than that.

The loonie has taken a hit as a result of the BoC’s change of position. GBP/CAD climbed by more than a cent and a half up to 1.5850, where it currently trades. Meanwhile CAD/USD dipped by a cent to a level just below parity, which represents a two-month low. This is a bit of a knock to the loonie but we do expect the currency to outperform GBP in the coming months, with another move down to 1.55 very much on the cards. 

Richard Driver

Currency Analyst

Caxton FX

Greek coalition talks collapse and prospect of new elections hurts euro

Sterling remains flavor of the month
Sterling has climbed by a further three cents against the euro in the past fortnight. Sterling’s progress against commodity currencies such as the AUD, NZD, CAD and ZAR has been ever more impressive in the past few months. Sterling has climbed by over 10% against the ZAR and NZD since mid-Feb, while it has advanced against the ZAR by the same margin since mid-March.

Sterling’s safe-haven status is behind its demand and this is not something we see disappearing any time soon. Also helping the pound was last week’s MPC vote against further quantitative easing. Whilst there will be some nerves surrounding the voting pattern (to be revealed by the MPC minutes next week), stubbornly high inflation seems to be of greater concern to the policymakers (thus making more QE harder to justify). Tomorrow’s Quarterly Inflation Report from the Bank of England will be highly relevant in this regard. A firmer inflation outlook is likely to be provided, which again should be broadly supportive of the pound.

Euro suffers from lack of Greek coalition agreement

Global investor confidence and risk appetite has taken a turn for the worse in the past fortnight, driven by concerns over Greece. Since the failure of the ruling Greek coalition to maintain sufficient votes at its recent election, major doubts have arisen as to whether Greece will remain within the euro. Coalition talks have collapsed and another election will be held in mid-June, which means the current uncertainty will be extended. As a result, Spanish and Italian bond yields are on the rise, with the former’s 10-year debt yields looking particularly alarming at fresh 2012 highs over 6.25%.

Should an anti-austerity coalition government surface from the current mess, then Greek bailout funds would be withheld, leading to default and a probable Greek breakaway. The knock-on effects in the eurozone and the global financial system as a whole are expected to be more drastic than those of Lehman’s collapse. It is no surprise then, that the euro has suffered a significant decline, with perceived safer-currencies such as sterling and the US dollar filling the void.

GDP data out of the eurozone was very mixed indeed this morning. Italy broadly stuck to the script by contracting by 0.8% in Q1 of this year, while French growth remained stagnant. However, the German economy grew by 0.5% in Q1, which helped the eurozone economy as a whole avoid a technical recession by posting a 0.0% GDP figure. This development has given the euro a mild boost today but with so much austerity still to be delivered in the eurozone and today’s forward-looking economic sentiment surveys showing a fairly sharp decline, eurozone growth is highly likely to return to negative territory this year.

Sterling is trading at €1.25 today, which represents near enough a three and a half year high. We are not calling a top to this pair’s ascent just yet either, with nerves surrounding Greece likely to deteriorate over the coming weeks. In risk averse conditions, the pound has understandably traded a little softer against the US dollar, coming off its highs of $1.63 to trade two and a half cents lower today. This pair could well test the $1.60 level fairly soon, though we are not anticipating any major collapse.

End of week forecast

GBP / EUR 1.26

GBP / USD 1.5950

EUR / USD 1.27

GBP / AUD 1.61

Over or under valued?

The pound is trading near six-month lows against the euro; the Australian currency is at post-float highs against the US dollar; and the euro is also at 15-month highs against the greenback. Most would agree that these levels – as well as many other pairings at present – do not reflect fair value. However, there is a great deal of benefit to be had in the longer term from having an undervalued currency.

A weak currency provides a real boost to the country’s exporters and this has been targeted as a key route to recovery by many global economies, in particular the UK. Britain needs to rebalance its economy and in the longer term a weak currency should encourage that process. Unfortunately it also exacerbates inflationary pressures, but there can be little doubt that over a longer time frame, the British economy stands to benefit from a lower pound – even if that isn’t immediately apparent for those heading abroad this Spring!

The US dollar is also very weak at present, and this has become the subject of some debate. As a major importer, the US does not necessarily stand to benefit from a weak currency and indeed the Fed has reiterated its commitment to a strong dollar. Its market value tells a different story however, and the greenback is unlikely to claw back losses until the Fed take steps toward tightening monetary policy.

The Chinese yuan has been at the heart of the ‘currency wars’ debate. The Chinese export sector has been booming on the back of a hugely undervalued yuan, much to the consternation of other countries. With inflation particularly high in Asia, China is now beginning to allow the steady appreciation of its currency, but this will be a slow process. China can ill afford to slow its rate of growth too drastically.

The countries that have shown extraordinary resilience to the strength of their currencies include Canada, Australia, and New Zealand., which have all reached multi-year highs against the US dollar in recent months. This strength, though warranted, is far from supportive for the economy and Canadian policymakers in particular have expressed their concern. We’re certainly unlikely to see any material intervention in the market to curb this strength, but comments talking down the currency should have the same effect.

In the case of Australia, such is the demand from China’s booming economy that exporters appear capable to withstand the strength of the aussie dollar. High levels of risk appetite combined with soaring commodity prices look set to keep higher-yielding currencies well-supported throughout year. Indeed the aussie and kiwi dollars could have even further to climb in the short term; who would want to bet against them frankly? These currencies may well be overvalued, but a turnaround in trend remains a distant prospect at best.

Richard Driver

Senior Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

The Aussie, the Kiwi and the Loonie- will the good old days of two or three to the pound return?

GBP/AUD: 1.56

GBP/NZD: 2.10

GBP/CAD: 1.56

These are the current interbank rates for sterling against the aussie, the kiwi and the loonie (Canadian dollar). Four years ago, one pound would buy you two and half aussie dollars, almost three kiwi dollars, and well over two Canadian dollars. These levels are reflective of historically riskier currencies versus the size and safety of the UK economy in years gone by. So, will we see these sorts of levels again or must be consigned to a new trading range?

In the case of the export-driven Australian and New Zealand economies, these have benefitted on a huge scale from the rise of China. Now the world’s second largest economy, China is a major trading partner to these two antipodean nations, and with commodity prices so high, their currencies have appreciated strongly. The higher interest rates of these two economies has for the past few years also provided investors with a far higher yield than those available in the UK, the US or Japan for example. This interest rate differential is set to be maintained for at least the next couple of years to come. The global recession hit the UK far harder than either Australia or New Zealand and it will take some time yet before a full recovery is established and it cope with fully normalised monetary policy (ie higher interest rates).

The loonie has also had reason to perform well, though for different reasons. Canada’s economy has benefitted from a broad rise in oil prices and from improving conditions in the US economy, its main trading partner. Canada’s economic fundamentals are solid – far more so than the UK’s - and the loonie had appreciated against the pound despite having equally low central bank interest rates.

None of the factors that have caused these ‘growth-linked’ currencies to appreciate against the pound, particularly the strength of the world’s two largest economies, look likely to fade any time soon. It would therefore be of huge surprise even in the long term to see a return of the levels of four years ago. The outlook for the British economy, in comparison to the “riskier” ones discussed above, looks distinctly pessimistic. With UK suffering economic contraction in the last quarter of 2010 and continuing to struggle with persistently high inflation, it might be argued that sterling is presently a riskier currency than the aussie dollar on a fundamental level. The day the pound has fully regained, for instance the near 40% it has lost against the aussie in the past 4 years, looks a very long way off indeed.

Although we actually view sterling to be undervalued at present (many others do not), it certainly appears that the current lowly trading ranges are set to continue for some time.

Richard Driver
Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.