April 2013 Outlook: Sterling edges higher as debt crisis resurfaces

After an awful start to the year, sterling has benefited from a welcome boost on the exchange rates in recent weeks. A couple of positive domestic economic developments have helped matters but events in the eurozone have been the key driver, helping to put the UK’s troubles in perspective. Domestic growth data in March did little to significantly improve the outlook for the UK recovery, though a couple of bright spots have provided a much-needed source of hope. There has also been a lack of further dovish leanings within the Bank of England, though we do expect more QE to be announced in May.

There was a collective sigh of relief that Cyprus avoided an unprecedented euro-exit and more

importantly that the eurozone banking system avoided the shockwaves which would inevitably follow. Nonetheless, events in Cyprus have understandably shaken the euro in the past month. The bailout deal that Cyprus reached with the Troika will leave the country deep in recession for a long time to come but this won’t be the market’s primary concern. Alarm bells are ringing following mixed rhetoric from within the EU leadership over whether the “bail-in” – where private investors and depositors, not taxpayers footed the bill for the refinancing – represents a special case or not. Some dangerous precedents have been set and with other larger eurozone strugglers such as Portugal and Italy exhibiting some tell-tale signs of crisis further down the line, the euro could be set for a troublesome few months.

GBP/EUR

Cyprus has investors fleeing for safety

Sterling looks to have bottomed out against the euro for the time being. The wave of anti-sterling sentiment has abated for now, amid a feeling that most of the bad news is already out in the open with respect to the UK economy. If the last few weeks have taught us anything, it’s surely that all the bad news is certainly not out in the open with respect to the eurozone.                      

                            

The pound emerged from the Annual Budget more or less unscathed, despite Osborne revealing that the Office of Budget Responsibility has slashed its 2013 GDP expectations from 1.2% to just 0.6% (which will most likely be undershot). Osborne effectively passed the buck to the Bank of England in terms of efforts to stimulate UK growth, directly expanding its mandate to that effect.

The latest from the Bank of England is that Mervyn King and his two fellow doves (Fisher and Miles) remain in the minority on the key quantitative easing debate, with the other six members seemingly too concerned with rising UK price pressures. In addition, the March MPC minutes revealed that there were fears surrounding an “unwarranted deprecation in the value of the pound,” which will concern many of those betting against the pound. We feel safe predicting that there will be no dovish majority in favour of QE in this Thursday’s MPC meeting, though we see a probability that we will see the voting swing in favour in May.

UK Q1 GDP figure comes into focus

Growth in the UK clearly remains very weak indeed. February’s data revealed the worst monthly construction growth in three years, whilst manufacturing is also firmly in contraction territory. Gladly, there was some relief in that the dominant UK services sector posted its best figure in five months and February’s 2.1% retail sales growth was excellent.  However, the key issue of whether or not the UK economy will avoid a triple-dip recession, when its Q1 GDP figure is announced on April 25, remains finely balanced. The March PMI figures released over the coming sessions will be highly significant; this morning’s manufacturing update got things off to a weak start but as ever, the pressure will be on Thursday’s services figure to deliver again.

Dangerous precedents will hurt the euro

While, there have been some rare sources of positivity with respect to domestic developments, this pair’s recent climb is explained mostly by events in the eurozone. Cyprus stole the headlines; the dreaded euro-exit has been avoided once again but the market has been left with some rather uncomfortable lessons. In a fundamental shift in eurozone banking relations, private individuals and companies with large amounts of cash in European banks now find themselves at risk of other potential ‘bail-ins’ in other struggling nations. This new credit risk is likely to leave a major psychological mark on euro-depositors and will have many heading to the exits and targeting perceived safer options like the GBP and USD.

Where will the next debt crisis hotspot be? Italy is looking a decent bet. Political instability is not the only issue the country faces, economic contraction remains a major issue and perhaps more pressingly, the health of Italian banks is deteriorating at an alarming rate. If things continue at this rate then Italy could find itself in a similar position to Cyprus, in need of recapitalising its banks, with Germany opposing a fix-all bailout from the European Stability Mechanism.

Some dangerous precedents have been set in Cyprus in terms of depositors being forced into a ‘bail-in,’ senior bondholder suffering haircuts, major and extended capital controls being implemented, the ECB imposing strict deadlines on their liquidity provision. Lines in the sand have been drawn, which are fundamentally likely to undermine confidence in the euro.

Debt crisis to one side, eurozone data has remained disappointingly true to its downtrend.  Monthly growth data from Spain, France, Germany and the eurozone as a whole has all undershot expectations, which suggests that Draghi is being more than a little overoptimistic with respect to his expectations that the region’s recession will stabilise soon. Naturally, events in Cyprus have hurt confidence and sentiment gauges.

Sterling has recently posted seven-week highs of €1.1890, although this pair currently trades over a cent off this level. We do see GBP/EUR recovering further in the weeks ahead, particularly if the BoE delays QE this month and the UK services figure is solid. Asian reserve managers already appear to be responding to eurozone developments by taking a step back from the euro. We see this trend continuing, which could take this rate as high as €1.20 in the weeks ahead.

GBP/USD

Sterling finally enjoys a bounce

There is no doubt that sterling’s safe-haven status has waned in recent months, in line with the loss of the UK’s AA credit rating. It has therefore been no surprise to see the USD benefit from the lion’s share of safe-haven currency flows stemming from increased tensions in the eurozone. Nonetheless, the pound has managed to eke out some gains in the past three weeks or so, despite the uptrend in US economic figures.

Those economic figures have revealed a particularly strong increase in US retail sales and industrial production. However, with housing market data mixed and consumer sentiment gauges indicating some weakness, there remains more than enough cause for concern to see the Fed continuing with QE3 for the time being. Indeed, the Fed recently downgraded its 2013 GDP projections in anticipation of a fiscal drag later this year.

More improvements in US labour market

As ever analysis from inside the Fed and therefore throughout the market, will focus on the US labour market, from which the news has been distinctly positive over the past few weeks. The US unemployment rate dipped back down to 7.7% in February- its lowest level since February 2009, while the headline figure revealed 236,000 jobs were added to the payrolls – the biggest monthly increase in a year. There is plenty here to fuel the Fed hawks’ calls for scaling back QE3 but the bottom line is that Bernanke and his fellow doves still require further progress. They may well get what they want as this Friday’s key US labour market update once again promises to be robust.

There were some notable phrases within the Fed’s March statement, among which was the emphasis that the central bank has the ability to vary the pace of QE3 in response to changes in the US economic outlook. So it really does seem as if they are gearing us up for fazing QE3 out, though this remains conditional to labour market progress.

Sterling may well face some short-term weakness if the UK services figure disappoints and there is room here for a move down to $1.5050. However, our baseline scenario is for a further upward correction for this pair. A move up towards $1.55 is possible in the weeks ahead, though this comes with the caveat that the UK must avoid a triple-tip recession (no sure thing). Beyond this near-term upward correction, we maintain a negative outlook for this pair in H2 2013, in line with our positive outlook for the US dollar.

GBP/EUR: €1.20

GBP/USD: $1.53

EUR/USD: $1.27

Richard Driver
Analyst – Caxton FX

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BoE edges towards QE, Fed edges away, while the eurozone remains firmly in recession

We have to hold our hands up and admit that we were caught well and truly offside with respect yesterday’s MPC minutes. We did not even fully expect David Miles to continue voting for QE but not only did he stand firm, he recruited to additional doves to his cause in the shape of Paul Fisher and (more significantly) Sir Mervyn King. With the merits of an interest rate cut also carefully discussed, it was no surprise to see sterling take a beating as a result. We have to now change our position on the BoE’s monetary policy outlook and expect an additional top-up of QE around May time. Not good news for sterling, which continues to suffer from weak growth and the high probability of a UK debt downgrade.

By contrast, the minutes from the US Federal Reserve’s recent meeting gave a real boost to the US dollar last night. They revealed that Bernanke & Co are assessing when and how to scale back their QE3 operations, which was a major driver of dollar-weakness in the last few months of 2012. There have been hints that substantial improvements to the US unemployment rate would be needed before QE3 was wound down but the minutes revealed there was some support for doing so before such improvements are seen. It goes without saying that there remains majority support for maintaining QE3 as it is until greater progress is made with the US recovery and no change to this looks particularly imminent. However, the discussion and the divergence of views within the Fed could lead to a tapering off of QE3 later on in the year. This is why the dollar has rallied.

From the eurozone, we have had yet more weak growth data. A German economic sentiment survey was excellent earlier on in the week but this morning’s PMI figures pointed to a slowdown in the powerhouse economy this month. The German manufacturing sector remained in growth territory by only the smallest margin. Meanwhile, French figures pointed to a sharp dip further into contraction, against expectations of stabilisation. The same is true for the eurozone as a whole, which is set to contract again this quarter.  This is being reflected in a weaker euro today, though GBP remains very vulnerable. 

Richard Driver
Currency Analyst
Caxton FX

Caxton FX Weekly Round-up and Outlook

Weak UK data puts further downward pressure on the pound

The prospects for a strong return to growth for the UK retail sector in January seemed very reasonable based on anecdotal evidence but Friday’s -0.6% stopped us dead in our tracks. When you combine this with the Bank of England’s Quarterly Inflation Report, which highlighted an outlook of weak growth and persistently high inflation over the next few years, it is little wonder that sterling has failed to bounce back in the past few sessions.

The MPC minutes are released on Wednesday and despite poor economic figures, we believe it is more likely that the lone QE voter David Miles dropped his vote than actually recruiting other members to his cause. The high inflation outlook really doesn’t seem consistent with additional QE, particularly while the Funding for Lending Scheme is providing the UK economy with support. Whilst Sir Mervyn King did state last week that the MPC stands ready to do more QE if necessary, we still believe his doubts over how much more this can achieve will dominate the voting in the coming months.

What hasn’t been helpful to the pound today have been Martin Weale’s weekend comments supporting a weaker pound to aid exports and address the UK’s current account deficit. Some might have interpreted this as a rare foray into the dangerous field of verbal intervention but we doubt it was much more than an example of wishful thinking.

Euro gets away with awful eurozone GDP figures

GDP data from throughout the eurozone, which significantly included Germany, was very disappointing last week. The euro is trading at a three-week low against the US dollar as a result of this confirmation that the eurozone recession is worse than many had feared, but levels above $1.33 are still pretty firm. Meanwhile, the euro continues to bully the pound down below €1.16.  

News out of the eurozone may have been bad last week but hopes are rather higher for this week’s eurozone data. Further improvements are expected within this week’s key German economic sentiment and business climate gauges. Meanwhile, Thursday’s eurozone PMI figures are expected to point to stabilization, even if the region does remain in recession territory.

US dollar enjoying plenty of demand amid firmer data

Recent headlines out of the US have been upbeat; weekly unemployment claims data improved sharply, while manufacturing and consumer sentiment figures also impressed. This provided a timely contrast with awful data out of the UK and the eurozone and may well have reminded many players why the USD should, in our view, be preferred to the EUR and GBP (in spite of QE3). The week ahead brings the minutes from the last Fed meeting (Wednesday), which could well reveal some discussion as to when QE3 can start to be scaled back. The bar remains pretty high in respect to this but discussion alone should be USD-positive.

End of week forecast

GBP / EUR	1.1500
GBP / USD	1.5400
EUR / USD	1.3400
GBP / AUD	1.5100

Sterling is trading below €1.16 this afternoon and we suspect the rate will head lower from here, with levels close to €1.15 representing a realistic target. It continues to prove tricky to call a bottom on GBP/USD’s slide but we think the pair will take a close look at $1.54 before a bounce is in sight.

Richard Driver
Currency Analyst
Caxton FX

January Outlook: GBP/EUR/USD

The end of 2012 was characterised by euro strength and dollar weakness, with sterling’s performance falling somewhere in between. We have seen GBP/USD rally to fresh highs lately, while GBP/EUR has posted new multi-month lows. Whilst our central scenario is that we will see these two trends reversed over the course of 2013, we note significant short-term risks to sterling vis-à-vis the euro. A weak UK GDP figure for Q4 2012 or a loss of the UK’s AAA credit rating are likely to keep GBP/EUR below €1.25 in the coming weeks, which is significantly below where we see it trading by this time next year.

GBP/EUR

Sterling suffering from UK triple-dip fears

December’s growth data pointed to a disappointing slowdown in November, with the UK’s key services sector only narrowly avoiding a monthly contraction. We have been warned in no uncertain terms by the Bank of England that the UK economy could well have contracted in Q4 2012. The available figures do indeed point to this, even if it is likely to be only marginal. Still, talk of a triple-dip recession is hardly going to foster a mood of confidence towards the UK recovery.

Looking ahead, the near-term outlook for UK growth is likely to be flat, as the economy wrestles with ongoing weakness in demand from the eurozone. We are simply not seeing the rise in UK exports that is necessary and with the eurozone poised to continue contracting throughout the first half of this year, this problem is unlikely to be addressed.

Chancellor George Osborne’s Autumn Statement, delivered in December, told us that the UK government is sticking to its guns on fiscal consolidation, which is likely to continue constraining growth, though we agree that this approach is essential. However, weak growth in combination with Osborne’s failure to make progress on bringing down the country’s soaring debt levels are likely to convince at least one of the major credit rating agencies to downgrade the UK’s triple-A rating. This is a risk for sterling, though we are among those who are sceptical about just how much this would hurt the pound.

In terms of BoE monetary policy, we still only have one MPC member (David Miles) voting in favour of more quantitative easing. The vast majority of the voters appear content to allow the effects of the Funding for Lending scheme to continue feeding through and unless we see evidence of further significant economic weakness, we don’t expect any more QE until at least the second half of 2013. As such, this month’s BoE meeting should yield no major developments, though the release of the MPC minutes on Jan 23 will be as closely watched as ever.

Euro strong but fundamentals point to a decline

As far as the euro is concerned, we have to admit that we are surprised to report GBP/EUR’s recent decline to an eight-month low below €1.2150. Supporting the euro is the fact that Greece is out of the woods for the time being and eurozone tensions have eased accordingly. The key driver of the euro’s resilience, as ever, is the perpetual diversification of USD into EUR by Middle and Far Eastern central banks. 

Nonetheless, we continue to foresee a euro decline through 2013, led by declining economic fundamentals and ongoing eurozone risks. It goes without saying that a weaker euro would benefit the eurozone economy. However, using rhetoric to this effect was a rather dicey move for EU officials last year, amid concerns over the very existence of the euro. We should see greater opportunity for policymakers to take advantage of calmer markets and talk up the merits of a weaker euro this year, without highlighting any existential crisis on the part of the single currency.

In terms of what to look out for this year, elections in Germany and Italy stand out as risk events, as does the likelihood of a Spanish sovereign bailout request sooner rather than later. Fortunately for the euro, Germany doesn’t go to the polls for another nine months, while Greece will likely stay out of the headlines for time being. Longer-term, we do expect the eurozone’s problem child to continue missing its targets, whilst there is also a risk of a breakdown of the Greek coalition.

Political uncertainty in Italy poses one of the most significant risks to the euro in the short-term; elections are likely to be held in March. This should put Spanish bond yields under pressure, as would a Moody’s downgrade of Spanish debt to junk status, which is looking probable based on comments made by the rating agency last October.

Sterling has bounced off its multi-month lows in the €1.2150 region and is currently trading around €1.2350. We expect this pair to remain fairly stable around this level in January, before edging back up towards €1.25 in the coming months.

GBP/USD

US steps away from the fiscal cliff

2013 has kicked off with a bang thanks to the rather predictable eleventh hour deal to avoid the US fiscal cliff. The absence of such a deal would have seen highly damaging tax rises and spending cuts coming into the force on January 1. The US Congress has taken a leaf out of the eurozone’s book by effectively kicking the can down the road but fiscal tightening will nevertheless be a major feature of the US economy this year. The Congressional Budget Office is expecting the US economy to grow by around 2.0% in 2013, which factors in a 1.4% reduction due to spending cuts.

The fact is that nothing of any real substance has yet been decided on American fiscal reform. The next two months will be the subject of further fierce negotiations on what cuts are made and where. The dysfunction of the US political system over recent years almost guarantees a further headline grabbing crisis in the coming months. Indeed, Moody’s and Standard & Poor’s have ramped up the pressure by branding this week’s deal “insufficient.”

Where does this all leave the GBP/USD pair? Well, the dollar has performed remarkably poorly in recent weeks and sterling actually mustered the strength to rally to an impressive fifteen-month high of $1.6380 in early New Year trading. However, the dollar is showing some initial signs of a rebound with this pair having retreated by over two cents from the aforementioned high.

Buying USD above $1.60 remains attractive

Put simply, we have seen any level above $1.60 as a strong opportunity to buy USD for a while now, so current levels of $1.6150 still look highly attractive. We have to admit that this pair finished 2012 significantly higher than we expected, but we remain confident that the greenback will find its feet in 2013. Behind this is a belief that economic fundamentals will acquire a greater share of market focus this year. With the US economy easily outpacing its US and UK counterparts, even after the effects of fiscal consolidation are factored in; increased focus on economic performance should benefit the greenback. In the short-term though, January should provide some more shelf-life for this pair above $1.60.

One month direction:

GBP/EUR: €1.2375

GBP/USD: $1.61

EUR/USD: $1.30

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Currency Round-Up: GBP/EUR, GBP/USD

Euro under pressure as ECB indicates cut to deposit interest rates 

The euro has been hit by a few different factors in the past few sessions. ECB President Draghi gave the single currency a knock last Thursday by revealing that whilst there would be no change to the Bank’s policy this month, we might expect some monetary easing next year. From Draghi’s comments, we no longer draw the conclusion that the ECB will cut the headline interest rate in Q1 next year. However, there were real indications that if growth disappoints and eurozone nerves spike in the coming months, we could see a cut to the deposit rate in a bid to encourage banks to step up lending.

Both the ECB and the German central bank (the Bundesbank) have delivered some fairly gloomy growth predictions in the past week. The former now sees the eurozone economy contracting by 0.3% next year, after previously predicting growth of 0.5%. Meanwhile, the Bundesbank disappointingly slashed its forecasts for German growth next year; reducing its June forecast of 1.6% growth to 0.4%.

We have had some good news today on the German front however, with a key economic sentiment survey hitting a seven month high. The latest sentiment and confidence surveys out of Germany suggest the country may narrowly avoid a recession, though a contraction in Q4 2012 looks highly likely. The German economy may not be in as weak as many had expected but the hopes for the rest of the eurozone are rather dimmer. This could well be highlighted by Friday morning’s eurozone PMI growth figures.

Italy hits the headlines as PM Monti announces resignation plans

Technocratic Italian PM Mario Monti dropped a bomb over the weekend by announcing his intention to resign once the Italian parliament has passed its 2013 budget. Berlusconi is waiting in the wings but his approval ratings suggest this is too big a mountain for even him to climb. Nonetheless, this political uncertainty - which raises serious question marks over Italy’s ability to deliver the necessary cuts and economic reforms to keep bond yields stable - could weigh on the euro significantly in the coming weeks and months.

All eyes on US Federal Reserve QE decision

Last week’s surprisingly strong figures from the US labour market are unlikely to satisfy the US Federal Reserve at its meeting over the next two days. We expect the Fed to decide to replace Operation Twist (which is set to be concluded) with a further $40bn in asset purchases, to bring its QE programme up to $80bn per month. There are various tweaks that the Fed can make to its monetary policy, to which the US dollar will respond differently. Given that sterling is trading at a very healthy rate of $1.61 at present, we would urge dollar-buyers to act now.  

End of week forecast

GBP / EUR	1.2450
GBP / USD	1.60
EUR / USD	1.29
GBP / AUD	1.53

Sterling has enjoyed a welcome little recovery against the euro amid some rather negative eurozone developments. At €1.24, we have not abandoned hopes of one last push for €1.25 before the end of the year. There is not much to get excited about with respect to sterling at present but we do expect enthusiasm towards the euro to wane from here. A move below €1.23 is looking increasingly unlikely.

Richard Driver
Currency Analyst 
Caxton FX

Caxton FX Weekly Round-Up: Spanish bailout issue to weigh on euro

Market frustrations with Spain on the rise

Spanish PM Rajoy’s failure thus far to accept the inevitable and make a formal request for a bailout has weighed on the euro in recent sessions. The week ahead brings plenty of interest; we are due to see Spain’s draft budget for 2013, the results of the Spanish banking sector’s recent stress tests and an economic reform programme that is likely to be a prelude to a bailout package. Even if these developments are welcomed by the market, we still think that Rajoy will wait until after Spain’s regional elections on October 21, which leaves several more weeks of uncertainty and frustration. This should delay any further euro rallies.

On the Greek front, we have seen some alarming headlines that the budget deficit is nearly twice as large as initially estimated. Talks between Greece and the Troika are now on a one week hiatus, so the market is left with alarming rumours of the need for a third Greek bailout and another Greek debt restructuring. The option of granting Greece more time to meet its bailout targets is gaining support but at this stage we are very much in speculation territory.

Concerns over eurozone growth have returned to the fore this week, after another awful German business climate survey. The risks of a German recession are rising, a development which the periphery can ill-afford.

Sterling firm ahead of final GDP number

The pound is performing well across the board at present. Eurozone concerns have returned after an August lull, while the central banks of Japan and the US have both eased monetary policy further, leaving sterling to reap the rewards. In addition, UK data has improved in recent weeks and the BoE seems to be content for the time being to delay any further QE of its own.

Sterling should be able to hang on to its recent gains against the euro and perhaps even build upon them, provided that Thursday’s final UK GDP number for Q2 does not suffer a downward revision to the already worrying   -0.5% reading. This release, which is likely to remain unrevised, is the only major event on the domestic calendar this week. By and large, the market’s gaze will be firmly fixed upon Spain.

US dollar soft after QE3 decision but continues to look poised for a bounce

Sterling remains at heady heights close to a 13-month high against the US dollar, thanks in no small part to the Fed’s decision to do a third round of QE earlier this month. However, the dollar’s behaviour since the decision suggests the move was more than a little bit priced in. Certainly the pound has climbed against the greenback but it has really stalled at the $1.63 level, so much so that we expect the rate to fall back in the coming weeks (provided that Rajoy doesn’t surprise us with an early bailout request)

End of week forecast

GBP / EUR	1.2625
GBP / USD	1.6150
EUR / USD	1.2800
GBP / AUD	1.5600

Risk appetite is pretty weak at present and the flow of news out of the eurozone is predominantly very negative. There remain disagreements over the EU banking union, over the legality of the ECB’s bond-buying programme, over the cession of Catalonia from Spain and much more besides. With this in mind, the GBP/USD rate’s ceiling of $1.63 looks likely to hold firm in the coming sessions. Meanwhile against the euro, sterling looks better placed to climb further. A move back up above €1.26 is a likely one this week.

Richard Driver

Currency Analyst

Caxton FX

Bank of Japan follows suit and eases monetary policy but the yen remains strong

 Last night’s monetary policy decision from the Bank of Japan saw further support provided to the Japanese economy. The BoJ added to its existing asset purchase programme by Y10trn, taking the total purchases to Y80trn. This Y10trn increase has come earlier than many expected and was certainly more than most market players expected. BoJ also extended the deadline for the end of the programme by six months to the end of 2013.

Nerves over the global economy are a major factor behind the BoJ’s decision. The US recovery remains shaky, the risks of a Chinese hard landing are rising, while there is little doubt that the eurozone has not seen the worst of the current economic contraction.

Global conditions have contributed to what the BoJ has described as a “pause” in the domestic Japanese economy. BoJ Governor Shirokawa has said the Japanese recovery has been set back by six months thanks to a prolonged global economic slowdown. Exacerbating the domestic growth outlook is the fact that a territorial dispute between China and Japan threatens to disrupt trade relations, something Japan can ill-afford.

Also in the BoJ’s mind will be the desire to curb the appreciation of the yen, which is hurting the Japanese economy. Particularly in light of the US Federal Reserve at last announcing QE3 this month, another move from the BoJ was always likely. However, the yen hasn’t weakened off today as much as the Japanese official would have liked. It has retraced almost all of last night’s losses, which demonstrates that there is no guarantee that QE will weaken a currency. 

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Outlook: Further upside potential for euro

ECB plan triggers euro rally

Mario Draghi alluded to doing “whatever it takes” to save the euro a month or so ago and at last week’s ECB press conference, he outlined just what he meant by that. ‘Super Mario’ as he has been called, revealed a plan that involves the ECB purchasing unlimited amounts of peripheral eurozone nations’ bonds. This has already brought down Spain’s bond yields but as Moody’s has warned today, this does not solve the crisis, it merely buys EU politicians (and not the ECB) the time to address the region’s fiscal and structural shortcomings.

The ball is now effectively in Spain’s court to negotiate acceptable conditions of a bailout that would include ECB intervention in the bond markets. So we are back to the familiar balancing act of Germany extracting sufficient austerity measures without going ‘over the top.’ This could potentially weeks but there is plenty to watch out for in the interim.

Wednesday should bring the German Constitutional Court’s ruling on the legality of the European Stability Mechanism and the eurozone’s fiscal compact. The court is strongly expected to approve both initiatives but a complaint made today by a German MP regarding last week’s ECB bond-buying plan has raised the prospect of another possible delay to the decision, which has ramped up market nerves again.

Wednesday also brings the Netherlands' general election but the euro looks likely to be spared another political saga at this stage, with the latest polls indicating a close race between two pro-Europe parties.

QE3 could finally arrive this week

Going into last Friday’s non-farm payroll figure the chances of the Fed delaying QE3 for the time being were fairly well balanced but it now seems highly likely that Ben Bernanke will at last pull the trigger on Thursday. Ironically, data did reveal that the US unemployment rate did fall to a rate not bettered since January 2009. Unfortunately as the employment change figure revealed, this was not because more jobs has been taken up and will be of little comfort to the Fed. QE3 is priced into a decent extent after Friday’s dollar sell-off but there is every chance we could see another wave of risk appetite give the greenback another knock this week.

Hints of a Q3 rebound for the UK economy

 August’s PMI growth figures from the manufacturing and services sectors were much better than expected last week. In addition, data also revealed that UK manufacturing and industrial production grew at their fastest rates in 10 and 25 years respectively, bouncing back from June’s slump. This summer’s London Olympics also look likely to have made quite a sizeable contribution to the domestic growth, which has caused many to revise up their GDP forecasts for Q3. All this means that QE concerns should not apply any weight to the pound for the next few weeks at least.

Although the euro’s upward climb has stalled today, the prospect of QE3 from the Fed and a positive ruling from the German Constitutional Court could well give the single currency some further strength. This is likely to keep the GBP/EUR pinned close to or even temporarily below the €1.25 level. Against the USD, matters are rather different as the pound currently sits only marginally off a near-fourth month high. Renewed upside potential for the EUR/USD pair could well help the GBP/USD hang on to these gains in the short-term but we continue to expect a reversal in the coming weeks.  

End of week forecast

GBP / EUR	1.2450
GBP / USD	1.6050
EUR / USD	1.2890
GBP / AUD	1.5300

Richard Driver

Currency Analyst

Caxton FX

September Monthly Outlook: GBP/EUR, GBP/USD

August was another strong month for the single currency as the financial markets continued to take comfort in ECB President Draghi’s pledges to do “whatever it takes” to save the euro. There were no major swings among the major pairings, with August typically being a sleepy month where traders and policymakers alike take their summer vacations. Despite a recent upturn in US economic figures, the dollar remains on the back foot, with QE3 speculation more prevalent than ever.

Recent domestic data suggests conditions have improved somewhat in the past month, which gives hope to the market and consumers that the UK economy can yet stage some sort of recovery in the second half of the year. The Bank of England will be content to see how this bounce in activity progresses, so fears of imminent quantitative easing should subside for the time being. Moreover, with a busy calendar for the US and the eurozone in the coming weeks, the UK economy is very much out of the spotlight at present.

The month ahead could well be a pivotal one in the timeline of the eurozone debt crisis. We are seeing the European Central Bank preparing to launch a programme of unlimited bond-purchases as part of a wider bailout package for Spain. The pressure will now build on Spanish PM Rajoy to make the necessary request for help but the conditions Germany pushes for is likely to be subject to tense negotiations.

Next week (September 12) brings the long-awaited decision from the German Constitutional Court on the legality of the European Stability Mechanism and the fiscal compact agreed earlier in the year, around which there is considerably uncertainty. There is also plenty of political risk in the form of a general election in the Netherlands, while the Troika will spend much of September assessing Greece’s attempts to reform before deciding on whether to release the essential next aid tranche. In addition to all these eurozone events, we will learn whether the Fed will finally pull the trigger on QE3 this month.

GBP/EUR

Sterling remains at strong levels against the euro; it is quite clear that the market has spent recent weeks waiting to see how September’s events panned out before punishing the euro any further. Indeed, whilst decisions and concrete actions have yet again been conspicuous by their absence, comments from ECB policymakers and eurozone political leaders have been falling on sympathetic, or rather, hopeful ears. This has fuelled a rebound for the euro.

Signs of life in the UK economy

The UK economy has enjoyed some good news in the past week in the form of some better than expected manufacturing and services sector growth figures, with the latter in particular raising hopes for a recovery. UK unemployment continues to make progress, with the jobless rate falling to an 11-month low of 8.0%. However, the market will need more convincing that the worst of this double-dip recession is behind us before sterling really begins to reap the benefits of improved data. The initial Q2 GDP figure of -0.7% was revised up to -0.5% but confidence is understandably still very fragile. The Bank of England looks content to remain in ‘wait and see’ mode with respect to the need for further QE, so the risks to sterling in this regard are limited for at least the next month.

Will Super Mario save the day?

Positivity surrounding an imminent bond-purchasing plan to deal with soaring Spanish and Italian borrowing costs has been the key feature of the debt crisis in the past few weeks. Timescales as to the launch are immensely tricky to pin down due to the need for Spain to request help from the ECB but the central bank’s fire-fighting measures are likely to be seen a positive for the euro when it does finally come about.

However, these unconventional measures do little to address the fundamental issue at the heart of Spain and Italy’s predicament – their lack of competitiveness. The eurozone periphery cannot bounce back with the euro as overvalued as it continues to be (regardless of the depreciation we have seen this year). Indeed the ECB’s commitment to fire-fighting this summer has exacerbated the situation by strengthening the euro. Crisis management policies like bond-purchases will not see the eurozone through this crisis. We have seen this year that ECB interest rate cuts weaken the euro and for us, it is only a matter of time before the ECB takes this option again, finally putting concerns over inflation to one side. The incentive to cut rates is all too clear; the ECB itself has this week significantly downgraded the eurozone’s growth prospects for both this year and next (possibly as low as -0.6% and -0.4% in 2012 and 2013 respectively).

The ECB and Germany’s opposition to granting the ESM a banking license also continues to stand in the way of any so-called ‘silver-bullet’ solution. Such a move would effectively give the permanent bailout fund unlimited access to ECB funding, eliminating the concerns that linger over inadequate firepower.

Huge risk events ahead in September

The next major obstacle in store is the German Constitution Court’s ruling on whether the new role for the ESM (the permanent bailout fund) and the eurozone’s fiscal compact complies with German law. If it does not, then this would be disastrous for the euro and while the probability is of a positive outcome, the risks to the contrary are significant. September 12 is made all the more important by the Netherlands’’ general election, which has been centred on the issue of the debt crisis. If anti-austerity parties do as well as polls are suggesting, then this is likely to weigh on the single currency.

Concerns over Greece are likely to come to the fore again this month, as the Greek coalition struggles to work through another €11.5bn of spending cuts and as the Troika returns to complete its review of Greece’s efforts to address its fiscal position. A positive Troika report is necessary in October if Greece is to receive its essential next emergency loan, without which it will default and most likely exit the eurozone.

Sterling may well have another slow month against the euro in September as the market prices in a (temporary) resolution to Spain’s crisis. However, we do see this pair resuming its uptrend beyond the short-term, slowly creeping higher towards, though probably falling short of €1.30 by the end of the year. €1.25 should provide plenty of support and we don’t see sterling weakening below this level but equally, provided the German constitutional court give a positive ruling on the ESM and fiscal compact, sterling could well spend much of the coming weeks below €1.2650. 

GBP/USD

Sterling is flying at a 3 ½ month high at present, despite the UK economy’s significant underperformance of its US counterpart. The QE3 issue continues to haunt the US dollar and delay what we continue to believe will be a robust end to the year for the greenback. There is no doubt that the US Federal Reserve has engaged in greater discussion of further monetary accommodation, with several policymakers convinced of the need of QE3. However, Ben Bernanke chose not to utilise his annual Jackson Hole speech to signal another round of QE, though crucially he said nothing to discount it.

Can the US dollar avoid QE3?

It does appear to be a case of ‘when’ not ‘if’ with regard to QE3. The Fed’s reasoning on QE3 seems to have changed from a stance of committing to more QE in the event that the US recovery deteriorates further, to a commitment to QE unless conditions markedly improve. Economic figures out of the US have been somewhat improved in the past few weeks, which may well convince Ben Bernanke to keep his powder dry on September 13. However, there is every chance that Q4 will bring the decision the market is hoping for.

The sounds out of the Bank of England in recent weeks have given the market some reason to look kindly upon the pound. A cut to the BoE’s already record-low interest rate has effectively been discounted and Mervyn King appears content to wait to see the impact of its Funding for Lending Scheme before introducing further quantitative easing. Whether or not more QE comes in November really depends on growth figures in the interim but the latest indicators do suggest a mild upturn.

Nonetheless, we continue to envisage a significant move lower for the EUR/USD pair in the coming months. If this comes about, it will weigh on the GBP/USD pair to a great extent. The euro’s rally against the USD is looking increasingly stretched at current levels of $1.2650 and given that we see this pair below $1.20 by the end of the year, we do expect GBP/USD to retreat significantly from the $1.59 level where it is trading at present. A rate of $1.57 is realistic in the coming few weeks. 

Richard Driver 

Currency Analyst 

Caxton FX

US fiscal cliff a major danger to the US dollar

The most immediate danger to the US dollar is quite clearly posed by QE3. The US Federal Reserve’s monetary policy outlook should be a little clearer after Bernanke’s speech in Jackson Hole this afternoon. If it is not, then the Fed’s meeting and press conference on September 13^th should yield plenty of clues.

Whilst data over the past month or two suggests that US economic growth is recovering from its slumber in the first half of 2012, there is plenty of uncertainty ahead with the US ‘fiscal cliff’ drawing closer.

What is the fiscal cliff? The end of 2012 will see tax cuts come to an end and spending cuts dramatically, which are expected to weigh on US GDP dramatically. Tax cuts that will expire include a 2% payroll cut for workers and tax breaks for businesses, while tax hikes related to President Obama’s healthcare law will also kick in. The Congressional Budget Office estimates that the effects of all this could be a reduction in US GDP by a staggering 4.0% in 2013, while two million jobs could be lost resulting in a 1.0% rise in unemployment. So with the fiscal cliff capable of plunging the US economy back into recession, the stakes are extremely high.

                                                                                                                              

The US economy is faced with taking the pain and addressing its fiscal position in an early but huge hit, or spreading the pain over a longer period in order to safeguard a still fragile recovery (a familiar debate to followers of the UK political approach to austerity). As last year’s ‘debt ceiling’ debacle demonstrated, deadlock in the US political system can cause huge delays to major policy decisions.

In addition, this fiscal cliff issue comes in the context of an election year, so there will be no decision made on how to approach tax and spending moving forward until the leadership is determined in early November. A stop-gap measure to delay the tax rises may well come before the end of the year but you can be confident that any decision that is made will come right down to the wire.

What are the implications for the US dollar? Well, as ever there are two sides of the coin. The concerns over the US economy and the fears of recession could drive the dollar down in line with its deteriorating economic fundamentals. Contrastingly, the threat to the world’s largest economy could see the market flood back into the safe-haven US dollar. Inevitably, both strategies will be adopted but which truly prevails is uncertain.

Our bet is that the US dollar will be hurt by the fiscal cliff issue. This will likely be the case whether the US ‘goes over the cliff’ or whether delaying tactics are adopted. The can-kicking that has been evident in the eurozone has been a major weight on the euro over the last couple of years and the market response to more of the same from US policymakers will be the same.

However, the fiscal cliff is by no means the sole point of focus for the financial markets in the second half of 2012. Of course, this all comes as the eurozone debt crisis reaches new levels of seriousness. Indeed, we doubt that the fiscal cliff issue will be enough to stop the EUR/USD pair dropping significantly below $1.20 by the end of the year. The fiscal cliff will weigh on the dollar, but not to the same extent that the debt crisis will weigh on the euro.   

Richard Driver

Currency Analyst

Caxton FX

Will Bernanke signal QE3 at Jackson Hole on Friday?

The US Federal Reserve’s annual retreat to Jackson Hole, Wyoming is always a headline-hitter. In 2010, Fed Chairman Ben Bernanke signalled QE2 in his Jackson Hole address and hopes are sky high that he will usher in a third round of quantitative easing tomorrow afternoon. Coupled with the eurozone debt crisis, US monetary policy has been the market’s obsession for a long time now.

The US recovery certainly hasn’t bounced back as expected from the weakness prevalent in the first half of the year. However, US data has been on an uptrend of late. We have seen monthly jobs growth improve for three consecutive months, whilst housing figures and consumer sentiment have also been on the up. In addition, data this week has revealed that the US economy grew at an annualised rate of 1.7% in Q2, rather than the initial estimate of 1.5%. This won’t have gone unnoticed at the Fed.

The minutes from the Fed’s last meeting stoked QE3 earlier bets this month, hinting that Bernanke & Co were preparing to act - “many members judged that additional monetary easing would likely be warranted fairly soon.” However, the wind was soon knocked out of the market’s sails when Fed policymaker Bullard stated that the minutes were “stale,” pointing to the upturn in recent US growth data as good reason for investors not to get ahead of themselves.

Nonetheless, it is probably fair to say that the majority of market participants are expecting Bernanke to signal QE3 tomorrow. It’s without doubt an extremely close call but our bet is that he will fall short of this benchmark, particularly in light of recent data. The Fed has various other policy options at its disposal, such as giving guidance on how long he expects US interest rates to remain “exceptionally low.” The bar has been set high though, only a QE3 signal is like to satisfy the market’s appetite tomorrow.

What will be the market’s response to the absence of a QE3 hint? Well, equities will no doubt take a hit and commodities and precious metals would follow suit. As for the dollar, well it should rally if Bernanke disappoints. Even if Bernanke gives the market what it wants, with QE3 priced in to the extent that it is, there is a good chance that investors will choose to take profit on short-dollar positions, which again would strengthen the greenback. With this in mind, we would prefer to be long of the dollar ahead of Jackson Hole. 

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Round-up: Dollar poised for rally

Pressure on for revised UK Q2 GDP figure

Last week’s all-important Quarterly Inflation Report from the Bank of England provided sterling with support just when a return to the €1.25 level was looking probable. King seemed to discard the option of another interest rate cut, describing it as potentially “counterproductive” and the likely effects to be “neither here nor there.” There were no real signals that the BoE is poised to introduce further quantitative easing, which again was supportive of the pound. The MPC minutes released on Wednesday should provide further clarity in this regard; we expect a unanimous decision to hold fire on more QE.

In addition to being less dovish than expected on monetary policy, Mervyn King also stuck to his guns in arguing that UK growth is not as weak as headline data has suggested. King’s comments have increased hopes and expectations that the initial -0.7% GDP figure for Q2 will be revised up. This was supported by last week’s better than expected, although still alarmingly weak in the bigger picture, manufacturing and industrial production figures from June. If an improved GDP figure is not forthcoming on Friday 24th August, then sterling could well be hit hard.

ECB has done nothing so far but hopes remain high

Despite the ECB having failed to take any concrete action at its meeting at the start of this month, the euro remains well away from its late-July lows. This is largely thanks to ECB President Draghi’s indications that the central bank is gearing up to resume the purchasing of Spanish and Italian bonds, in an effort to bring down their unsustainably high borrowing costs.

However, while some short-term relief for the euro would likely follow some concrete action from the ECB, it will be no panacea. Bond-purchases will be tied to very strict conditions with respect to economic reforms. Mario Draghi has suggested that ECB bond-purchases would only occur once a country had requested help, but this request may not come if Germany is too strict with the conditions it attaches. At the very least, German demands may could easily delay progress. In any case, bond-purchases took place last year but we are back in panic mode once again, so we find it hard to believe that ECB action will provide anything more than a short-term lift for the single currency.

Despite the positive sentiment that has built towards the euro over the past few weeks, we continue to hold a distinctly bearish view of the single currency over the rest of 2012. While sterling has plenty of its own domestic issues, chief among which are ongoing weak growth and the threat of the UK losing its AAA credit rating, it should be able to climb higher towards €1.30 this year.

GBP/EUR is currently trading at €1.27 and another push higher may prove tricky in the short-term as GBP/USD is looking ripe for another downward correction. Despite ongoing debate within and outside the US Federal Reserve, the central bank is still resisting the urge to announce or even signal QE3. This case has been strengthened most recently by last month’s better than expected US labour market update. The dollar looks well-positioned for a return to strength this month then, which could bring the GBP/USD rate well down from the current $1.57 level.

End of week forecast

GBP / EUR 1.2750
GBP / USD 1.5550
EUR / USD 1.2250
GBP / AUD 1.5000

Richard Driver

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

Sterling set for a tough month

As has been the case for many months, eurozone concerns dominated market sentiment in July, so much so that the euro hit fresh multi-month lows across the exchange rates. Immediate concerns over the situation in Spain and Greece hurt confidence significantly, with weak economic growth across the globe adding to concerns. However, market sentiment and the euro have picked up considerably in recent sessions.

After the so-called progress that was made at the June EU Summit, there have been no material developments. The peripheral bond markets are always a good indicator of market tensions with regard to the debt crisis and Spanish 10-year bonds have hit fresh euro-era highs above 7.6% in recent weeks, with equivalent Italian debt setting its own record above the 6.5% level. Whilst economic growth throughout the eurozone is contracting sharply, Spain is edging towards a full-blown bailout and Greece could yet fail to secure its next bailout tranche, which is essential if the country is to avoid collapse.

Economic conditions in the US continue to provide plenty of cause for concern. The US economy slowed from a pace of 2.8% in Q4 2011 to a pace of 1.5% in Q2 2012. Poor performance in the world’s largest economy stunted the US dollar’s progress in recent weeks by increasing speculation that the US Federal Reserve is edging towards introducing the much-debated QE3 measure. However, the Fed’s recent meeting produced yet more ‘wait-and-see’ rhetoric, which has taken some weight off the dollar for the time being.

News out of the UK has also been far from comforting. Recent data has indicated that the domestic economy contracted by 0.7%, which is a shockingly poor figure well below expectations. The Bank of England has introduced another round (£50bn worth) of quantitative easing and the government has initiated an interesting new Funding for Lending Scheme to encourage banks to step up lending, but the effects of these are some way from being felt. In the meantime, UK growth is expected to remain very weak indeed. Sterling still holds some safe-haven demand, though this may be insufficient for it to avoid losses against the euro and dollar this month.

GBP/EUR

Having hit near four-year highs up towards €1.29, this pair has since erased its gains and at the current level of €1.26, it is back where it started in July. Whilst we do maintain that the pound will remain on its longer term uptrend, we anticipate some further short-term sterling softness in the coming weeks.

Spain spooked the markets in July, with borrowing costs soaring well above the 7.0% level amid a request from the Spanish regional government of Valencia’s request for financial aid and concerns of similar emergency needs across Spain’s regions. Spain’s banks have already agreed a bailout with international creditors and it has certainly discussed a full-blown sovereign bailout with Germany, which continues to demonstrate growing bailout-fatigue. In terms of austerity and economic reforms, PM Rajoy is doing all he can but investors are still hammering Spain in the bond markets. A sovereign bailout is looking increasingly unavoidable.

Last week’s ECB meeting was the most eagerly-awaited in a very long time but the market was left wondering what could have been. Draghi had a plethora of options available to him and after he stated that he would do “whatever it takes” to preserve the euro, he delayed any action whatsoever. The decision not to cut interest rates was unanimous after June’s 0.25% reduction, despite ECB President Draghi predicting that the eurozone economy is likely to recover only very gradually, whilst noting significant risks to further deterioration. Q2 was an awful one for the eurozone, with weakness in the periphery spreading to core states including Germany. The latest German and French manufacturing figures reveal a sharp contraction and eurozone unemployment remains a major issue, having recently reached a fresh record high of 11.2%.

Draghi disappointed the markets by suggesting that the European Stability Mechanism will not be granted a banking license, which had been previously indicated by an ECB policymaker and would have greatly increased the bailout funds’ firepower. Importantly, Draghi indicated that the ECB may move to buy up peripheral debt to ease pressure in the bond markets, but his comments fell short of a pre-commitment, never mind concrete action. German resistance to ECB bond-buying and demands for fiscal restraints represent a key obstacle to ECB emergency action.

Whilst alarm bells ring in the eurozone, the UK economy is also in a very weak state, which is best demonstrated by the recent-0.7% GDP figure from Q2, leaving the UK economy firmly in recession. Initial signs have not been positive for Q3 either; the UK manufacturing sector posted its worst figure in three years and the UK services sector gave its worst showing in eighteen months in July.

The Bank of England is clearly concerned with economic conditions in the UK, having introduced another round of quantitative easing in July to support the economy. The MPC voted 7-2 in favour of the £50bn top-up and there were suspicions that another dose would be approved at its recent August meeting in response to the latest shock GDP figure, though sterling has been spared this development. The government has also taken its own action to try to drag the UK out of recession in the form of its Funding for Lending initiative, designed to incentivise UK banks to increase lending, something that the Project Merlin initiative failed to do.

It needn’t be all pessimism towards the UK economy; there remains some fairly strong scepticism over the reliability of the awful initial Q2 UK GDP figure and in combination with the improved weather conditions, hopes for a significantly stronger second half of the year are not misplaced. The effects of the additional round of QE, the Funding for Lending programme should help the UK return to growth, though this may have to wait until Q4. Unfortunately though, initial expectations that the London Olympics will add 0.5% to UK GDP this year are receding.

The sharper than expected recession has highlighted the question marks over the UK’s treasured AAA credit rating. Rating agency Moody’s has retained its negative outlook for the UK’s credit rating, though fears have been quelled somewhat by Standard & Poor’s recent reaffirmation of the UK’s top rating with a stable outlook.

Sterling is trading at €1.26 at present, which represents a pretty aggressive decline from its multi-year high of €1.2878. With weak UK growth figures set to flow this month, we expect this rate to retrace further in the coming weeks down to €1.25. There is a risk that this pair will revisit its June lows of €1.2270 but on balance we think this is unlikely.

GBP/USD

Sterling has remained range-bound against the US dollar over the past month, fluctuating between $1.54 and $1.57. The news out of the US economy has broadly been very disappointing; June’s labour figures were alarmingly poor, manufacturing data was shaky and retail sales contracted sharply. In addition, the US economic growth rate of 1.9% (annualised) in Q1 slowed down to 1.5% in Q2 - almost half of the rate we were seeing at the end of last year.

Naturally, weak growth figures saw bets on QE3 ramped up yet again, which has been a thorn in the US dollar’s side for some time now. Ben Bernanke disappointed the market yet again in his July US Federal Reserve Press Conference. There was no QE3 announcement, nor any real signals that a move is imminent. Clearly this is good news for the US dollar, if not for global market confidence.

The recent release of July’s US non-farm payrolls figure should free up the US dollar to make some gains this month. Data revealed that 163 thousand jobs were added to the payrolls in July, which represents the best showing in five months and should ease fears of a sharp slowdown in the US for now. One thing is certain though, QE3 will remain very much on the Fed’s list of options for the foreseeable future. We see the Fed pulling the trigger on QE3 at some point in Q4.

Despite Moody’s recent reaffirmation of the UK’s AAA credit rating, market confidence in the pound appears to be waning thanks to a steady flow of weak UK growth figures. More of the same can be expected this month and to make matters worse, anecdotal evidence suggests the Olympics will fail to provide the economic boost that was initially expected. The Bank of England held off from adding another dose of QE at its July meeting but suspicions of another top-up will grow with every negative piece of UK data.

We hold a negative view of the EUR/USD pair in the coming weeks, based on continued uncertainty on all fronts; sharp contraction in eurozone growth, a possible Spanish bailout, Greek uncertainty and a continued imbalance between talk and genuine action. If EUR/USD heads down towards $1.21 as we expect, then this would almost ensure GBP/USD declines even if UK news is positive. Given that we expect news out of the UK to be negative, we feel this pair’s downturn could be quite aggressive. A move down $1.52 looks realistic in the coming weeks.

Richard Driver

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

Caxton FX Weekly Round-Up: More Euro Weakness Ahead

The euro-bashing continues amid delays to the German court ruling

The euro has hit fresh lows against the dollar and the pound in the past week thanks to further declines in US stocks, widening peripheral bond yields and heightened eurozone concerns.

Germany’s constitutional court has decided to wait until September to give its ruling on whether the changes to the European Stability Mechanism and the fiscal compact are legal according to German law. This sets back the implementation of the progress made at the EU’s last Summit and ensures a high degree of market uncertainty over the rest of the summer. The decision goes against the pleas from the German government for a swift ruling that would help contain the debt crisis.

ECB President Draghi has tried to calm market tensions, asserting last week that the euro as currency was irreversible, but investors failed to take much comfort. The euro has been unjustifiably high over the past two years given its waning economic fundamentals and soaring debt levels; the euro’s sell-off since early May is the correction that we have had to be very patient in waiting for.

Bank of England ‘Funding for Lending’ scheme impresses

Sterling is benefitting from plenty of safe-haven flows at present, which has seen GBP/EUR hit a fresh 3 ½ month high of €1.2768. There have even been some small pockets of optimism in the UK economy of late; industrial and manufacturing production growth improved in May thanks to shifting the Bank Holiday to June. The UK trade deficit even narrowed significantly in May. Last Friday saw the release of details relating to the Bank of England’s new ‘Funding for Lending’ scheme. UK banks will have access to £80bn worth of cheap loans and will be incentivized to pass this on to UK businesses. The markets responded positively to the programme, which starts in August, and sterling performed strongly. Nevertheless, the market will not kid itself into thinking the UK economy is going to gain much momentum in H2 of 2012.

UK inflation has come right down to a 34-month low of 2.4%, driven by weak domestic activity but this also been helped by the stronger pound. Low inflation clearly supports the MPC’s decision earlier this month to introduce further QE. The minutes from that meeting will be released on Wednesday morning and a unanimous vote in favour of QE could possibly be revealed, at least a strong majority. This shouldn’t weigh on sterling too heavily. UK retail sales data for June should again be positive on Thursday, helped by the Queen’s Diamond Jubilee celebrations.

US Federal Reserve Chairman Bernanke speaks again over the next two days and with data revealing on Monday that US retail sales contracted sharply once again in June, hopes are high for indications that QE3 is imminent. Despite ongoing weakness in US figures, we expect yet more of the same from Bernanke, a dovish tone but reluctance to signal QE3 for the time being.

Sterling is trading at €1.2720 today and continues to look poised for another push higher. The euro’s sell-off looks set to drag on further, particularly in light of the German constitutional court’s decision to delay its decision. At $1.56, sterling is performing strongly against the USD but we don’t see this lasting much longer. EUR/USD should weigh on the GBP/USD but we still see the pound holding up better than the euro.

End of week forecast
GBP / EUR 1.2775
GBP / USD 1.5550
EUR / USD 1.2175
GBP / AUD 1.5275

Richard Driver
Analyst – Caxton FX

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

The Swedish Krona has had a good run but the game could be up

Data has revealed that the Swedish economy took a surprise upturn in the first quarter of this year. This improved domestic economic performance has given the Riksbank the confidence to leave interest rates unchanged for the second consecutive meeting, though there remain calls for another cut within the central bank’s ranks.

A brighter picture in Sweden has coincided with a mild recovery in global equities and risk appetite, in the wake of May’s crisis of eurozone confidence. Greece has managed to form a coalition government and concerns surrounding a messy Greek default and exit from the eurozonehave eased, for the time being at least. Spain’s situation looked capable of spiralling out of control, with the country’s 10-year bond yields setting new euro-area records up above the dangerous 7.0% mark. Some progress has been made with regard to Spain; an agreement has been reached for the bailout of its banks and some unexpected decisions made at the recent EU Summit have eased some short-term concerns.

Whilst market confidence has turned distinctly negative in recent sessions, the positive Swedish data in recent weeks has provided plenty of support for the Swedish krona, suggestive of a strong second half of the year for the Swedish economy. However, we view the risks to market sentiment and developments in the debt crisis to be heavily skewed to the downside. As such we don’t see too much more upside for the krona from here over the next couple of months.

GBP/SEK

After this pair peaked close to 11.50 in mid-May, the krona has rebounded impressively over the past two months. Sterling has struggled against many of the riskier currencies in recent weeks. Global stocks have staged an impressive recovery from their May sell-off and the krona has tracked that bounce inrisk appetite.

Events in the UK have not helped sterling’s cause of late. Growth data has been consistently weak, suggesting there will be no swift bounce back out of the double-dip recession that the UK has found itself in. Data confirmed the UK economy contracted by 0.3% in Q1 and we expect another contraction in UK GDP in Q2. The Bank of England’s response to fading domestic activity has been to introduce yet more quantitative easing, which is of course a negative for the pound. This factor has contributed to GBP/SEK’s poor performance over the past couple of months.

The Riksbank decided to leave its interest rate at the current level of 1.50% in July. Only two votes out of six were in favour of another cut to the Riskbank’s base rate, with the majority satisfied with the upturn in Swedish activity. The Swedish economy grew by 0.8% between Q4 2011 and Q1 2012 and the Riskbank is expecting overall growth of 0.6% this year, up from previous estimates of 0.4%. We have seen some positive figures comes out of Q2 as well;Swedish industrial production rose by an impressive 3.0% in May, while industrial orders rose by 4.5%, which has sparked a good degree of optimism surrounding the Swedish growth outlook.

There remains plenty of reason for caution. Swedish unemployment is rising (up at 4.4% from 4.0%) and the Swedish economy remains very vulnerable to deteriorating eurozone conditions. This second factor will ensure that another interest rate cut later this year is always a possibility, but on balance we expect the Riksbank to hold fire. We don’t see much further downside for this pair and expect a bounce back above the 11.00 mark over the coming weeks.

EUR/SEK

This pair has come under some aggressive selling pressure in the past two months. The risks of economic disaster posed by the eurozone debt crisis are building every monthand this has seen the single currency take another sharp turn for the worse.

The short-term risks posed by Greece have eased now that a coalition government is in place but when the bailout term negotiations commence there is plenty of scope for alarm bells. Concerns over Spain have more than stepped in to fill the void; its banking sector has had to seek a bailout and despite significant progress at the recent EU Summit, Spanish bond yields remain dangerously close to 7.0%.

Investors are still sceptical towards the euro and rightly so – no long-term solution is in sight; the bailout funds are still insufficient, Germany continues to obstruct the introduction of Eurobonds, peripheral borrowing costs remain high and eurozone growth is contracting. Even the progress made at the recent EU Summit has been placed in doubt by the German constitutional court delaying ratification of the ESM changes and the fiscal pact. In addition, the euro’s yield differential has once again been reduced by a 0.25% ECB interest rate cut (to 0.75%) this month, with further monetary easing in the form of another rate cut or cheap loan offering likely this summer.

With the euro losing ground across the board, the SEK is shining out as a safer European alternative backed by stable domestic economic growth and low debt levels. There are plenty of rumours that the SEK is a popular target with the Swiss National Bank as it continues its project of recycling the euros it acquires whilst weakening the CHF.

This pair is trading at an 11 ½ half year low; whilst we do not expect any major progress in the eurozone over the next couple of months, we do expect to see this pair to benefit from a minor bounce after its sharp recent decline. The SEK remains vulnerable to major panic in the eurozone. A bounce up towards 8.80 over the coming weeks looks a good bet.

USD/SEK

As one of the safest currencies available, the US dollar has been a strong performer since early May, which has helped this pair continue the uptrend that has played out over the past year. Eurozone fears have reached new heights and the safe-haven dollar always strengthens in this environment.

The US dollar has not been without its own domestic issues though; the US economy slowed down sharplyover the first half of 2012, the Q1 GDP figure was revised down to 1.9% (y/y) from 2.2%. Consistently soft figures out of the US labour market in particular have ramped up speculation that the US Federal Reserve will announce a third round of quantitative easing (QE3). Regardless of the risks of QE3 this year though, we envisage enough safe-haven demand for the dollar to outperform.

We envisage plenty more gains for the US dollar in the second half of this year, with USD/SEK heading back up towards it recent highs around 7.30 in the coming few weeks, with fresh highs above 7.50 likely towards the end of Q3.

NOK/SEK

The Norwegian economy continues to shine, having grown by 1.1% in the first quarter of this year. The latest updates in terms of Norwegian manufacturing and industrial production were positive and retail sales growth was particularly impressive in May. There is no doubt that the Norwegian economy is proving extremely resilient to the global and eurozone economic downturn that has developed this year. Rising investment in Norway’s lucrative oil sector is providing steady support to growth and with forward-looking economic surveys looking positive;the Norges Bank has revised its GDP forecasts upward to 3.75% from 3.25% for 2012.

Clearly the Norges Bank has been eager to highlight the external threats to the Norwegian economy, most notably from the eurozone debt crisis. Indeed it stated in June that “turbulence and weak growth prospects abroad suggest the key policy rate should be kept on hold.”However, the Norges Bank is one of the few global central banks not inclined towards easier monetary policy and we currently expect an interest rate hike from the Norges bank around the turn of 2013. Of course, this will be highly sensitive to developments in the eurozone and how drastically this affects Norwegian exports.

The Norwegian krone is still a commodity currency and although Norway’s strong economic fundamentals have to a large extent offset the effects of declining oil prices on the krone, the slide has still weighed on the currency. Since the uncertainty triggered by the Greek elections in early May, the price of Brent crude has declined by almost 20% from $120 to under $100 per barrel.

This factor has contributed to a sharp downward correction in the NOK/SEK rate, dragging it down from two-year highs above 1.20 to current levels just above 1.14. We consider these levels to be much too low and are confident that we will see a strong bounce off these lows up towards 1.18 over the next few weeks.

Richard Driver
Analyst – Caxton FX

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