What the fiscal cliff could mean for the US and global economy

With the US fiscal cliff less than three months away, the International Monetary Fund has chimed in this week with its concerns for both the US and the global economy as a whole. The US is edging towards an enormous fiscal tightening the like of which we haven’t seen since 1947. The nerves, pressure and speculation surrounding the issue will only going to intensify as US politicians argue and stall their way through the final quarter of the year.

The IMF has estimated that if a deal isn’t reached to avoid a full-blown fiscal cliff, then the US could well plunge into recession next year. The organisation estimates that the US economy will grow by 2.1% in 2013, while the impact of the fiscal cliff would weigh on GDP by 2.2%.

While the fiscal cliff does not appear to threaten a global recession next year, it would certainly have a significant impact; rating agency Fitch has estimated that it would cut global growth in half. As far as eurozone growth is concerned, developments from within the region could easily tip the IMF’s 2013 eurozone GDP forecast of 0.2% well and truly into recession territory regardless of the fiscal cliff. However, the organisation sees the failure to reach a compromise on the fiscal cliff knocking 0.4% off growth, which would seal the deal regardless.

If an agreement between the Republican controlled Congress and Democrat controlled Senate, it is highly unlikely that the payroll tax cut will be extended - there appears to be consensus on this issue. The expiration of this tax cut then will likely shave 1.0% off US GDP, which is nearly half the amount that the IMF is estimating of a full-blown fiscal cliff. This would leave global growth down around 2.6% in 2013, instead of the 3.6% the IMF is anticipating on the assumption a deal is reached. Unless US politicians pull a rabbit out of their collective hat, the fiscal cliff issue is likely to end in pain for all concerned, just how much pain is the real question.

Richard Driver

Currency Analyst

Caxton FX 

Market fears reach new heights as Spain edges closer to a sovereign bailout

The bad news for the euro just keeps on flowing. Spanish 10-year bond yields have now risen to a fresh euro-era high above 7.60%, which is a fairly accurate bellwether of market tensions that have built towards Spain and the debt crisis as a whole in recent sessions. Sustained yields above 7.0% pushed Greece, Portugal and Ireland into requesting a bailout and the chances of Spain following suit are rising all the time – another few weeks at current levels and Spain may have no choice but to ask for help.

Meanwhile, German 10-year bonds have recently fallen as low as 1.14%, and 6-month bond yields have even dipped in to negative territory; such is the appetite for safe havens, investors are actually willing to accept losses just to park their funds in the safety of German short-term debt.

The Spanish regional govenrment of Valencia has asked the central government for financial aid, and six other regions including Catalonia and Murcia are expected to do the same. Considering a €100bn bailout was only signed off for Spain’s crumbling bank sector on Friday, these signs of panic from Spain’s regions are the last thing Spanish PM Rajoy needs, particularly as he is trying to quell market fears by insisting that Spain will not require a full-blown sovereign bailout. Spain’s economy minister De Guindos is meeting his German counterpart Schaeuble today and there will be suspicions that a full sovereign bailout will be considered.

The IMF may well be hardening its stance on granting aid to failing eurozone economies, if the rumours of a possible withheld contribution towards Greece’s next aid tranche. So again, these Spanish headlines have come at unfortunate moment.

Spain is continuing to call for intervention from the ECB, De Guindos said on Saturday that "somebody has to bet on the euro and now, given the architecture of Europe isn't changed - who can make this bet but the ECB." If the ECB restarts its programme of buying up distress debt, then Spain can stop paying such high borrowing costs. The ECB has stood firm on this issue for nineteen straight weeks, claiming that the lead on solving the debt crisis should be taken by EU politicians. Stodgy progress in this regard is likely to force the ECB’s hand in the end, particularly as Italy edges closer to disaster.

Spain has major repayments to be made by October, so a full-scale Spanish bailout could well come before then. Amid all these concerns around Spain, Greece is heading towards the exit door, so it should to come as a surprise when we reiterate our bearish view of the euro.

Adam Highfield
Analyst – Caxton FX
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Caxton FX Weekly Outlook: further pain in store for euro

Spanish debt concerns drive GBP/EUR even higher

Spanish 10-year bond yields are up at 7.50% today, which represents yet another fresh euro-era high. One of Spain’s largest regional governments, Valencia, has requested financial help from the central government, and there are plenty of indications that more regions will follow suit. This has triggered widespread fears that the Spanish sovereign itself will need a formal bailout, in addition to the bailout that was signed off for the country’s banks on Friday. In addition, the Bank of Spain has said today that the country’s economy shrunk by 0.4% in Q2, in addition to its 0.3% contraction in Q1.

Greece is also back in the headlines this week; reports have emerged that the IMF may not contribute to the next aid tranche that the country needs by September to avoid insolvency. The IMF, along with the rest of the Troika, will be in Greece this week assessing the country’s spending cuts and reforms. The Troika seems highly likely to give a negative assessment of Greek progress.

On top of these debt–related issues, the week ahead presents plenty of risks for the euro in terms of economic data. Tomorrow’s set of eurozone, German and French PMI growth figures are expected to remain at very weak levels, in fact almost entirely in contraction territory. Wednesday brings a key German business climate survey, which is expected to hit a fresh-two year low. All of this negative eurozone data is likely to increase speculation as to another interest rate cut from the ECB early next month.

MPC minutes do little to hurt the pound

The MPC’s meeting minutes revealed a 7-2 vote in favour of the July quantitative easing decision, which is no great surprise in light of poor UK growth data, weak domestic inflation and rising risks from the eurozone. Sterling has actually weathered the recent domestic quantitative easing storm very well and we are not expecting another dose of QE in the next few months, if at all (provided a rapid deterioration in eurozone conditions can be avoided). An interest rate cut was discussed at the MPC’s last meeting, but we expect this will be the committees’ last resort and we are not expecting this will be utilized this year.

The week ahead brings the preliminary UK GDP figure for the second quarter of the year. Consensus expectations are of a 0.2% contraction and whilst an undershoot of this estimate would likely apply some short-term pressure on sterling, we still take a positive view of sterling moving forward, as we do of all safer-currencies.

The week ahead also brings the advance US GDP figure for the second quarter. A further slowdown is expected, though until the Fed makes some clear signals as to QE3, the dollar should remain on the offensive.

End of week forecast

GBP/EUR posted fresh 3 ½ year highs up towards €1.29 over the weekend and while the pair is trading only marginally above the €1.28 level at present, we expect new highs to be reached soon. €1.30 has come into view quicker than we expected and is now a realistic target in the coming fortnight. Heavy losses in the EUR/USD, which itself it trading at more than a two-year low below $1.21, have taken their toll on GBP/USD. Sterling has given back two cents to the dollar since last Friday, and is currently trading at $1.55. We expect this pair to revisit the $1.54 level in the coming sessions. Soaring peripheral bond yields should ensure global stocks remain under pressure, which is likely to pave the way for further dollar gains.

GBP / EUR 1.2925
GBP / USD 1.54
EUR / USD 1.1920
GBP / AUD 1.5200

Richard Driver
Analyst – Caxton FX
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Sterling/Euro June Report

Sterling has continued to rally against the euro in recent weeks, as conditions in the eurozone go from bad to worse. Uncertainty, as ever, is the buzz word. The pro-bailout New Democracy Party has edged ahead in the Greek opinion polls in the past week or so, which has lifted market hopes that the country can receive the additional funding it needs and remain ‘safely’ within the eurozone.  But there is plenty more debate to be had in Greece and few will be truly confident of a positive result ahead of the fresh elections on June 17^th.

The chances of a messy ending to the Greek saga remain very high. Even if a pro-austerity, pro-bailout coalition does emerge out of this month’s elections, they will still have to find a way to deliver the major reforms and deficit reduction that the country’s €130bn bailout agreement requires. The EU Commission reminded Greece earlier this week that its bailout payments remain highly contingent but whoever wins this month’s elections, you can expect some desperate efforts to have the bailout terms relaxed to a significant degree.

Greek concerns, though likely to return to the fore as the elections draw closer, have been put on the back burner for the time-being. True to form, another struggling eurozone nation has stepped up to fill the void – Spain, or more specifically, Spain’s banking sector.  Bankia, Spain’s fourth-largest bank, requires €19bn worth of recapitalisation and it is becoming more and more apparent that Spain will need help to shore up its banking sector. The issue is having a significant impact on Spain’s government borrowing costs, with 10-year bond yields climbing dangerously towards the unsustainable 7.0% level. As ever with this debt crisis, market fears build so much they become a self-fulfilling prophecy. In short, Spain is in very serious trouble and may have to seek external help, which is no small issue given it is the eurozone’s fourth-largest economy and will inevitably turn the market’s gaze towards the third-largest – Italy.

The UK economy is looking particularly downbeat at present, having been hit with the confirmation that it is firmly in double-dip recession territory. Unsurprisingly, consumer confidence has taken a sharp downturn. April’s growth data from the services and manufacturing sectors was poor and a gauge of UK retail sales showed the worst figure in almost four years. The last update from the UK labour market was a little more encouraging but we will need to see more than one good month before hoping for sustained improvements.

Amid all of this bad domestic economic news, as well as the grave threats posed by the eurozone debt crisis, it might be assumed that more quantitative easing is bound to be introduced by the Bank of England in order to drag the UK out of recession. Certainly the IMF has made its views known on the issue, encouraging the BoE to act soon to safeguard the UK economy.

However, the noises out of the MPC have not suggested that such a move is imminent, despite the recent sharp decline UK inflation from 3.5% to 3.0%. A key reason for this is that the BoE sees UK inflation in the medium term as equally likely to exceed its 2.0% target as undershoot it.  In addition, Spencer Dale has recently stressed the argument that the recent quantitative easing doses are still feeding through to provide stimulus and that a further round is not appropriate at present. This position is supported by the recent improvement in UK money growth.

With only one MPC policymaker voting in favour of QE at the MPC’s May meeting, in the form of David Miles, there is plenty of dovish recruitment to be done in the coming months if the BoE is to pull the trigger again on further monetary easing. Sterling seems safe in this regard for June at least, though eurozone risks could feasibly escalate sufficiently to prompt BoE action in July or August.  

So, despite the UK economy sitting uncomfortably in a double-dip recession and facing a prolonged period of period of stagnant growth and ultra-low interest rates, sterling looks free to continue taking advantage of an increasingly euro-negative environment. Sterling/Euro climbed a further two cents in May, leaving this pair with gains over 4.0% in the past two months. We envisage further gains for the relative safe-haven pound in June, with the Greek elections and rising Spanish bond yields providing plenty of motivation to exit the euro.

Richard Driver
Analyst – Caxton FX

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Caxton FX Weekly Round-up: Sterling Rallies

IMF boost emergency fund by $430bn but EUR remains pressurized

The weekend’s IMF and G20 meetings produced some real progress in the form of a combined $430bn of additional loans, to be used in the event of a deterioration of the eurozone debt crisis. Good news then, but Spanish 10-year bond yields are trading around the dangerous 6.00% level, and Italy’s equivalent debt is yielding 5.75% today, so it clear that the market remains characteristically skeptical.

The French presidential elections have increased the pressure being felt by the euro in recent sessions. Socialist candidate Francois Hollande received the most votes in the weekend’s initial round of voting and the euro, as well as European equities, has declined as a result. The final election will be held on May 6th and this political uncertainty is likely to weigh on the single currency in the meantime. The markets would probably prefer Sarkozy to remain in power, thus reducing the risk of a breakdown in cooperation between France and Germany on dealing with the debt crisis. Fresh concerns have also sprung up with respect to the Netherlands, which is likely to hold elections in light of the government’s collapse after failing to agree measures to slash its budget deficit.

As well as the weekend’s political concerns, the markets have had to digest some further disappointing eurozone economic data. A German manufacturing growth figure hit almost a three year low and figures out of the eurozone as a whole were equally alarming.

MPC's Posen gives sterling a boost

Sterling enjoyed a staggeringly strong week last week and has started the current one where it left off. MPC policymaker Adam Posen provided the main catalyst for the rally, with the minutes from the MPC’s April meeting revealing that he did not vote for further quantitative easing. The market may have got ahead of itself in pricing out the likelihood of further BoE quantitative easing. Posen may well have voted for no change due to the recent uptick in inflation and may have just preferred to see the current round of QE run its course (which it will have done by time of the MPC’s next meeting in early May). More monetary easing from the BoE is still a distinct possibility if UK inflation eases in the second half of the year and economic growth remains stagnant.

UK Q1 GDP figure to show some growth, albeit scant

Wednesday brings the release of the first quarter UK GDP figure. After last week’s excellent UK retail sales figure, we are fairly confident that we will not see another quarterly contraction. Estimates are falling around the 0.1% growth level, which is indicative of the uncertain footing from which the UK economy is building. Nonetheless, news that the UK has avoided a technical recession will be welcome (though the risks of disappointment are not insignificant).

Sterling is trading at almost a six-month high of $1.6150 at present and we continue to view these to be excellent levels at which to sell the pound. The Fed is likely to be more hawkish in its communiqué this week, whilst the US GDP figure is also likely to be impressive, which could well help the US dollar bounce back. Sterling is trading at almost a two-year high against the euro above €1.2250 and further gains are looking likely, though we may see upward progress stall as nerves kick in ahead of Wednesday’s GDP figure.

End of week forecast
GBP / EUR 1.23

GBP / USD 1.6050
EUR / USD 1.3050
GBP / AUD 1.5750

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Round-up: US economy goes from strength to strength

Private creditors finally participate in Greek debt swap

Greece managed to convince 85% of its private creditors to participate in the long-awaited debt-swap deal. This was converted into 95% participation when the collective action clauses were triggered to force some creditors to sign up. The deal represents the biggest sovereign debt restructuring in history.

The euro suffered from a classic case of ‘buy the rumour, sell the fact’ after the debt swap deal was agreed. The International Swaps and Derivatives Association has classified the Greek debt exchange as a ‘credit event,’ in which $3bn worth of credit default swaps are triggered. This places plenty of financial uncertainty back on the table, though the banking system is better placed to deal with in light of the ECB’s liquidity measures (3-year LTRO’s).

It is fair to say that the market is certain that this debt-swap is not the last time we’ll see Greece occupying the headlines this year. Many players expect Greece to be back in bailout territory before the end of 2012, which explains the rather muted response to the latest development. With regard to the second Greek bailout, Eurogroup head Juncker has indicated that it will be signed off this week and should include a significant IMF contribution.

US jobs figures impress once again and the dollar benefits

227 thousand jobs were added to the US non-farm payrolls in February, another excellent showing that highlights the pace of growth that is accumulating in the world’s largest economy.

The market will also have been impressed to see February’s growth in the US non-manufacturing sector pick up to its fastest pace in almost a year. In a recent speech, US Federal Reserve Chairman Ben Bernanke seemed to respond to the upturn in US growth by omitting reference to further US quantitative easing, to which the US dollar has responded positively.

The week ahead brings a statement from US Federal Reserve (Tuesday evening). If further optimism surrounding the US economy is revealed (which seems likely) then sentiment towards the USD should remain positive. This afternoon should bring some strong US retail sales figures to support this.

The relationship between the US dollar and US economic data is an unpredictable one but at present the two are demonstrating a positive correlation. Later on in the week, we will see some monthly consumer sentiment and manufacturing figures, all of which are also expected to be strong.

Sterling is trading just below €1.1950. Anything below €1.19, or above 84p, is looking a little too rich for the euro, bearing in mind that economic fundamentals seem to be turning the corner in the UK, whilst the eurozone economy continues to deteriorate. We are still having to patient for the GBP/EUR to kick on past €1.20 but in the longer-term we are sticking to this forecast.

Sterling has suffered a major downside move against the US dollar in the past fortnight, falling from just below $1.60 to the current level just below $1.57. We continue to look for lower levels as the US economy streaks ahead and as other safe-haven assets such as the Japanese yen lose their appeal.

End of week forecast
GBP / EUR 1.20
GBP / USD 1.56
EUR / USD 1.30

GBP / AUD 1.4950

Richard Driver

Currency Analyst for Caxton FX

Euro still rallying but for how long?

Euro recovers from S&P with a major bounce

The euro has responded impressively to Standard & Poor’s blanket downgrade of nine eurozone credit ratings (which wouldn’t have been the case had Germany been axed). The market is extremely short of euros and what we are seeing is those short positions being covered, particularly as hopes are raised for a Greek deal on private sector creditors. Whether or not a deal emerges remains to be seen, 60-70% haircuts have been rumoured but until there is an official announcement, the market remains completely in the dark. Unsurprisingly, a deal was not reached on Monday as was hoped and it looks like we may have to wait another few weeks for progress.

The euro has benefited from some remarkably positive eurozone bond auctions of late; the impact of the ECB’s cheap loan offering in evidence once again. Spain in particular saw terrific demand and yields also eased. On the data front, there was a staggeringly strong German economic sentiment survey which contributed to the euro’s best week in months. The IMF joined the party on Wednesday, with reports suggesting that it would be making a further $1 trillion available to the eurozone. This, predictably, was later revised down to “several billion dollars.”
So, there have been some genuine developments for the euro in the past week or so - S&P’s downgrade aside - but beyond the short-term, not enough to sustain further gains or even maintain current levels from our point of view.
Sterling struggling ahead of UK GDP and MPC minutes

Wednesday’s session is an important one as far as sterling is concerned. We will see the preliminary UK GDP figure for the final quarter of 2011, which is expected to show a marginal (0.1%) contraction. The minutes from the MPC’s last meeting a fortnight ago will also be watched closely for clues as to whether the Bank of England’s quantitative easing programme will be stepped up again in early February. Our bet is that it will but downside risks for sterling should be fairly limited on this front, with the market having priced it in to a large extent. The UK GDP figure could well have a material impact on the sterling exchange rates if it undershoots already pessimistic expectations.

UK unemployment numbers reached fresh highs last week and UK inflation declined aggressively, neither of which are positives for the pound. On a brighter note, UK retail sales picked up a little in December, which was to be expected in light of November’s appalling showing.

The euro is trading strongly this morning on the back of some positive manufacturing and services PMI data. There have also been some positive political developments this week; Germany has stated it is open to increasing the firepower of the eurozone bailout fund and there has been progress on details relating to the permanent bailout fund – the European Stability Mechanism (to be introduced later this year). The euro should be able to hang onto most of its recent gains, though further climbs look a push. With GBP/USD at $1.56 and EUR/USD at $1.3050, the dollar looks ripe for a recovery soon. At the end of the week, we are likely to learn the US economy grew impressively in the last quarter of 2011, which should improve the prospects for the US dollar regardless of any boost to risk appetite that it may trigger.
 
End of week forecast

GBP / EUR 1.20
GBP / USD 1.55
EUR / USD 1.2950
GBP / AUD 1.49

Richard Driver
Analyst – Caxton FX

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

Weekly Round-Up: Markets are punishing the euro

EU Summit fails to satisfy the market

Movements in the exchange rates yesterday indicated a clear dissatisfaction with the decisions (or lack thereof) made at last Friday’s ‘crunch’ EU Summit. Various commitments were made, notably in the form of a new fiscal compact that will usher in tighter budget deficit rules. This will guard against future sovereign debt crises cropping up in the future, but it doesn’t do a great deal to solve, or ease concerns surrounding the current and worsening eurozone debt crisis. The European Stability Mechanism (the permanent bailout fund) will be activated a year early in mid-2012 – another longer-term measure. A further €200bn of aid will also be made available – positive but hardly the sort of ‘bazooka’ style measure that has been mooted of late.

The European Central Bank has refused to step up its bond-buying and Italian bond yields have risen as a result. This reveals what the market thinks of the decisions made at last week’s Summit. Moody’s has joined fellow ratings agency Standard & Poor’s in warning of possible eurozone debt downgrades. Moody’s cited “an absence of decisive policy measures.” Decisive is the operative word here and the adjective that continues to elude EU leaders. With all three of the major rating agencies posturing, further eurozone downgrades are looking likely - the euro appears more vulnerable than ever.

The euro guarded against losses in the immediate wake of the EU Summit, but it has made a terrible start to this week. The market has had to come to terms with, and is pricing in, the fact that this eurozone crisis is going to roll on for months to come. This should not come as too much of a surprise, but expectations of ground-breaking progress really had reached new levels in the past fortnight. Accordingly, GBP/EUR has posted new nine-and-half month highs up towards €1.1850, and the euro has crashed towards fresh lows towards 1.3150 against the US dollar. The euro has fallen and fallen hard, and our pessimistic view of EU political stalling is finally being reflected in the exchange rates. In addition to the headline fiscal issues plaguing the euro, data this week is likely to highlight the economic issues the eurozone is facing. Eurozone manufacturing and services data is likely to stoke prevailing fears of another eurozone recession on Thursday.

Sentiment towards the US economy improving

Away from the furore surrounding the EU Summit, US consumer sentiment data hit a six-month high on Friday, providing further indication that the slowdown we have seen across the Atlantic for much of this autumn may well just be temporary. Caution will persist however, particularly with US retail sales figures disappointing today.

The picture is gloomier here in the UK; employment (Wednesday) and retail sales data (Thursday) provides plenty of scope for some sterling negativity as the week progresses.

Sterling is trading impressively above €1.18, and the euro looks hard-pushed to rebound in the current low-confidence environment. Key options levels at $1.3250 on the EUR/USD pair have now given way and safer currencies such as sterling and the US dollar have made an excellent start to the week. We can expect there to be further volatility this week and it certainly won’t be one-way, but we do expect the current risk-off climate to favour safer currencies and punish the euro. Currently trading at $1.56, sterling has held up pretty well against the US dollar, but a heavy EUR/USD pair should limit any upward sterling moves.

End of week forecast:
GBP / EUR 1.1850
GBP / USD 1.5550
EUR / USD 1.3125
GBP / AUD 1.5450

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

ECB rate cut could be positive for the euro

There have been plenty of positive developments for the eurozone of late. The IMF looks increasingly likely to be a third line of defence and it has been agreed that the European Financial Stability Fund will be able to guarantee up to 30% of troubled eurozone state’s bonds.

Most importantly, six major central banks last week announced coordinated liquidity measures to take the pressure out of the global, and particularly the European banking system. The unified emergency response has given appetite for riskier assets such as the euro a real shot in the arm.

We have also seen some progress in Italy, with new PM Mario Monti announcing a fresh 30bn austerity package, which should serve to appease the markets for the time being.

All eyes now turn to the Thursday’s monthly interest rate decision from the European Central Bank. A higher interest rate is typically positive for a currency and a rate cut a distinct negative. However, circumstances in the eurozone are anything but normal and a second consecutive monthly rate cut to the ECB’s base rate (currently 1.25%) could well be taken as sign that EU officials understand the gravity of the region’s problems and are acting proactively and assertively. Other liquidity measures are also likely to be announced by ECB President Draghi.

Friday brings a key EU Summit which has been hyped as ‘make or break.’ This is a bit overdone but there are plenty of signs that we will see some decisions made on fiscal union amongst eurozone states. Headlines today reveal that Merkel and Sarkozy have reached an accord on eurozone budgets and potential sanctions. The markets have been disappointed before and whilst investors are likely to hope for the best while the positive headlines flow, but many will be preparing for the worst.

Conditions in the US improve but not so for the UK

US economic figures have broadly taken a turn for the better in the past fortnight, suggesting the US economy can have a stronger 2012 than has recently been indicated. This has added to the improved sentiment in the market in recent sessions.

UK data has been less impressive; November’s UK construction and manufacturing figures revealed a further slowdown and have done little for the prospects of final quarter growth. Services sector growth enjoyed a minor uptick but levels are well off what we were seeing earlier in the year.

George Osborne was very negative indeed about the prospects for the UK economy in his Autumn Statement. The Bank of England will be sitting on the sidelines until February as far as more quantitative easing is concerned, so we will just have to hope that activity picks up in the next few months.

Sterling is trading at €1.1650, off its recent highs above €1.17 in light of an upturn in global risk appetite. Against the US dollar, sterling is trading more robustly up at $1.57, having bounced of lows of $1.54 in late November. We don’t see any major moves in the GBP/EUR pair this week but we may see EUR/USD continue to head higher as equities recover. This should keep GBP/USD well-supported, regardless of the growing concerns surrounding the UK economy.

End of week forecast
GBP / EUR 1.16
GBP / USD 1.5750
EUR / USD 1.36
GBP / AUD 1.50

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Euro suffers despite July ECB rate rise promise

The Bank of England kept interest rates on hold at 0.5% today, as it has done every monthsince March 2009. In reality, there wasn’t even an outside chance of a UK rate rise - the UK growth figures have just been too poor of late. Long-term sabre-rattler Andrew Sentance left the MPC last month, and now Mervyn King and his MPC doves are more in control than ever. Even if they did wish to change stance, the MPC would struggle to justify a rise before 2012, with growth so weak and household incomes so squeezed.

The IMF cut its forecast for UK growth in 2011 from 2.0% to 1.5% earlier this week, and we could well be in for a second quarterly growth figure as low as 0.2%. Mervyn King has repeatedly indicated that the UK’s soaring inflation levels are down to temporary factors that will subside next year, so the MPC are likely to ride out these high prices. With UK growth so soft, King is loath to hit the British economy with higher borrowing costs. Indeed, this morning’s UK trade balance data suggested consumer demand is really suffering at present, which took the shine off a narrowed deficit.

Unsurprisingly, the market didn’t respond to the BoE’s announcement; the release of the MPC minutes in a fortnight is likely to prove more market-moving. The market didn’t respond to the ECB’s unchanged 1.25% interest rate either. However, the market has moved since Trichet's press conference, and it has been a significant move.

Trichet delivered on the “strong vigilance” message with regard to upside risk to price stability, so a July rate rise is now more or less guaranteed. However, the euro has suffered a substantial slide on the news. The July rate rise was clearly fully priced in and traders have obviously seen now as an opportunity to take profit; the euro has given away half a cent to sterling, and over a cent to the US dollar. This may also be a reflection of some disappointment that Trichet refused to give any signal as to rate rises beyond July.

Despite the euro’s fall, the long-term outlook for a strong euro remains intact. Though with the market likely to refocus on the Greek situation in coming sessions, the euro could have some further downside in the short-term. Only when a Greek resolution arrives is the euro likely to really kick on from here. Sterling still looks fundamentally weak; none of its gains today have been made on its own merits.

Richard Driver
Analyst – Caxton FX


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Is the rally in commodity prices coming to an end?

In October last year, Brent crude oil was trading at around $80 per barrel. In January this year, it was trading just below $100, and on Monday of this week, it exceeded $126 per barrel, a high not seen since early 2008. However, in the past two days we have seen the price drop by $5 per barrel, and the price of gold has also dropped significantly. This begs the question –has the rally in commodity prices (as driven by oil prices) run out of steam?

The trigger for the recent sharp decline in oil prices on Tuesday can be attributed to Goldman Sach’s, who earlier suggested that investors should take profits after the International Monetary Fund voiced concerns that higher energy prices could hinder the global economic recovery. Speculators quickly jumped on Goldman’s advice; accentuating the price decline and making clear that the drop was the result of an independent intervention from a major market player rather than a natural slide.

So what’s the outlook for oil prices? Well, based on the International Monetary Fund’s downgraded economic growth estimates for the US and for Japan (two of the world’s largest three economies), demand for oil looks set to decline. However, geo-political tensions in the Middle-East are constraining the supply side and OPEC recently announced that Saudi Arabia is unable to increase output to cover the decrease in Libyan output.

In a recent blog on the Wall Street Journal Digital Network, a strong argument indicating that June could be a point at which commodity prices come off their peaks. In November 2008, Brent crude was trading under $50 per barrel, since then it has been on a steady uptrend. What triggered this rally? The Federal Reserve’s quantitative easing programme. – which is set to draw to a close in June; potentially cutting short the supply of funds currently directed into oil futures.

How might this affect the currency markets? Oil producing states such as Canada, Russia, Norway, and other commodity-linked economies such as Australia are currently benefitting from greater profits on their exports. This has been a major factor in the strong performance of their currencies in recent months. If oil prices continue to show signs of topping out, it may trigger investors to take profit on considerable gains made on riskier currencies.

Richard Driver
Currency Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.