What does the UK unemployment rate mean for monetary policy?

UK data delivered another surprise and according to the Office for National Statistics, the unemployment rate has dropped further to 7.1% from 7.4% bringing the 7% threshold given in forward guidance into question. With the unemployment rate now marginally above the benchmark, the need for the Bank of England to reassess the direction of interest rates is nearing.

Despite the labour market improving significantly faster than expected, the latest MPC meeting minutes suggest a rate increase is still unlikely to occur in the near future. The central bank sees no immediate need to raise interest rates, and with the inflation rate now on target there is even more room to maintain loose monetary policy. Of course the surprise drop in the unemployment will encourage the central bank to reconsider their view on the future for monetary policy, but the BoE will be cautious not raise rates prematurely.

This suggests that a re-evaluation of policy will rather result in an alteration in the central bank’s forward guidance, possibly a reduction in the unemployment benchmark to 6.5%, when the next quarterly Inflation Report is released on Feb 12. The market seems more excited about the fact that this unexpected result has brought the BoE closer to at least considering tightening policy, even if execution is not for a while yet. For now, this has been enough to keep demand for sterling rife.

Sasha Nugent

Currency Analyst

Caxton FX

What is more important? Rate increases or price stability?

It has now become common knowledge that the UK recovery is taking hold, and the next hurdle for the economy is to ensure this recovery can be sustained. The BoE have outlined in their forward guidance, that unless any of the thresholds are breached, they will maintain their current dovish stance, and re-evaluate policy once the unemployment rate has reached 7%.

Since the introduction of forward guidance, the markets have had their eye on the inflation and unemployment rate looking for signs to gauge the BoE’s next policy move. The labour market has improved faster than projected and inflation has also eased more quickly towards the BoE’s target of 2%y/y. In situations where unemployment figures surprised the market to the upside, demand for sterling increased, strengthening the pound. When lower inflation numbers have been revealed, sterling has taken a hit, as this dampened investor’s expectations of a rate increase in 2015.

Despite criticism, it is looking more like the central bank will not be forced to raise interest rates. Loose monetary policy has helped to support the recovery which continues to gain traction, all whilst price pressures have eased, now only 0.1% away from the target. Domestic demand is likely to strengthen, resulting in an upward pressure on inflation, but for the time being the BoE now has more room to maintain a policy which seems to be working.

A few months ago the market believed that inflation would remain above target forcing the central bank to take action and raise interest rates. With inflation easing, the BoE is no longer under pressure to do so, and the market seems to be forgetting that despite the dampened expectations of a rate hike, inflation that is in line with the central bank’s target is a good thing. Yesterday CPI unexpectedly came in below expected at 2.1%y/y and this immediately resulted in sterling weakness. What we saw was the pound being penalised for inflation trending towards the central bank’s target.

Sasha Nugent

Currency Analyst

Caxton FX

Caxton FX Weekly Report: Fed in Focus

Another week of vulnerability for sterling

Sterling looked less robust last week as a firmer euro managed to direct the rate below 1.19, and finally investors began to respond towards solid US data. This week, inflation and unemployment figures will be released and after comments from BoE member Weale regarding softer inflation, this figure will be watched carefully. Price pressures have eased significantly, and this has dampened expectations that the central bank will need to raise rates soon. Despite the pick-up in economic activity, lower inflation will allow the central bank to fulfil their commitment to maintain low interest rates in order to help absorb slack in the economy. Unemployment has been improving faster than the BoE has predicted and claimant count figures on Wednesday should also support the brighter labour market in the UK. The Bank of England will release the monetary policy minutes from their last meeting, and this should shed some more light on whether the MPC’s view about the UK has changed since the inflation report. Although it is unlikely that the MPC’s stance has changed dramatically, any significant comments here will most probably cause some volatility. Other figures such as retail sales and current account data may also offer sterling some support this week, however it will not be easy to rebound considering the heavy calendar for the eurozone and the Federal Reserve monetary policy meeting this week.

The euro bulls return

Today’s Eurozone PMI figures kick started a week packed with eurozone data. With the bullish euro investors managing to dictate trading in both EUR/USD and GBP/EUR, it doesn’t seem like things will be any different for sterling this week. The euro is still preventing the pound from driving the rate back up to 1.19 and we doubt the market will hesitate on putting more money into the euro if data provides upside surprise. It will most probably be more difficult for the euro to gain against the dollar despite some solid numbers. With the Federal Reserve’s monetary policy announcement on Wednesday, we may begin to see the single currency suffer at the hand of some investor repositioning just in case the Fed decide to surprise us with the beginning of tapering. There is more opportunity for the euro to gain against sterling this week, however if the Fed hold of tapering this month, this could provide the euro with another opportunity to drive the EUR/USD rate through 1.38.

All eyes on the Fed meeting

We are beginning to see signs that the market has begun to pay more attention to the more positive US figures we have seen of late. With the Federal Reserve monetary policy announcement only days away, US data will play an even more significant role in encouraging investors to reposition their portfolios towards the dollar. Although the case for a December taper has been building, many economists believe the Fed will begin to reduce stimulus in January. Therefore, if the Fed refrains from tapering this month, we doubt the market will respond by selling the dollar as aggressively as they did in September. It is likely that the greenback will experience some temporary weakness, however investors will eventually begin to prepare for a January taper. This is a fundamental week for the dollar and direction of both EUR/USD and GBP/USD hangs in the balance of the Federal Reserve announcement on Wednesday.

End of week forecast

GBP / EUR	1.1855
GBP / USD	1.6250
EUR / USD	1.3720
GBP / AUD	1.8350

Sasha Nugent

Currency Analyst

Caxton FX

What is new in the BoE November Inflation Report?

One of the most important things to take from the inflation report is the more positive view on the economy. In Governor Carney’s words, “For the first time in a long time, you don’t have to be an optimist to see the glass as half full. The recovery has taken hold”. Strong economic figures, particularly robust PMI numbers, have encouraged a brighter outlook for UK growth in 2013 and 2014. Consequently, the central bank has raised their forecasts for growth from 1.4% to 1.6% in 2013 and from 2.5% to 2.8% in 2014.

After CPI surprisingly dropped to 2.2%y/y, the BoE now projects inflation will be considerably lower than predicted in August. Although energy price rises are likely to result in an uptick in inflation in the coming months, weak domestic price pressure and the recent strengthening of sterling will keep the inflation rate trending towards the 2%y/y target. Assuming the Bank Rate follows the path of market yields, the inflation target will be reached a year earlier.

The central bank’s outlook for the labour market has also improved and the monetary policy committee now believe that there is a two in five chance that unemployment will reach 7% by the end of next year, and a three in five chance in 2015 (assuming the Bank Rate follows market rates). Considering the MPC have used the unemployment rate as a benchmark to re-evaluate monetary policy, there is a possibility that we could see a rate hike in late 2015. However, Governor Carney repeatedly highlighted the importance of reducing slack, claiming “A strong and sustained recovery is needed to put people back in work and use up the slack in the economy”. Therefore the MPC may hold back on raising interest rates until we witness such a “strong economy”. In addition, Carney outlined that a scenario where the Bank Rate was held constant “shows the potential advantages of keeping rates unchanged after hitting 7% unemployment”.

The main thing to remember is that despite the upward revision in growth projections, and confirmation that the recovery is strengthening, it doesn’t necessarily mean a rate hike is on its way. Although the unemployment rate is expected to reach the threshold earlier than predicted in the last inflation report, in Governor Carney’s words, “what really matters is what we will learn about the economy along the journey to that threshold”. We have seen how quickly the economic picture can change, and therefore it is important for focus to remain on what this picture is showing.

Sasha Nugent

Currency Analyst

Caxton FX

Caxton FX Weekly Report: Fed tapering decision weighs on greenback

Employment data was all Sterling needed

Although last week was a quiet week for UK data, claimant count figures gave sterling the boost it needed
to see the GBP/EUR rate touch the 1.19 mark. This week is a bit more eventful as Tuesday sees the release
of inflation figures at 09:30. This will be of particular interest as economic data has continuously pointed towards a stronger UK recovery, which has spurred doubt as to whether the timeframe given under forward guidance is appropriate. In a meeting with the Treasury committee, the central bank reinforced that if inflation breached the knockout condition of 2.5% in the medium-term, it would simply cause the monetary policy committee to assess why and then consider what action to take. A high inflation number may encourage speculation that the BoE will re-examine policy and ultimately raise rates earlier than the 2016 benchmark. The BoE monetary policy minutes due on Wednesday morning (09:30) will also be of interest, especially since the central bank didn't provide an accompanying statement following the announcement of the official bank rate. Retail sales figures released on Thursday are expected to follow the trend of recent UK figures and provide upside surprise. This should see sterling remain in control of the GBP/EUR rate, maintaining levels of 1.19 during the week. The GBP/USD rate will see a lot of volatility ahead of the all-important Federal Reserve meeting on Wednesday. The increasing likelihood that the Fed will delay tapering until at least the October meeting, creates a possibility sterling could maintain momentum against the US dollar.

Euro strength falters
Euro strength seen towards the end of August now seems like a distant memory. Since the start of September some eurozone fundamentals have been disappointing, allowing sterling to take advantage. This week sees the German ZEW Economic Sentiment due on Tuesday at 10:00, which is expected to improve to 45.3 from 42.0. Better eurozone figures are unlikely to provide the euro with much momentum, especially as negotiations regarding Portugal’s fiscal target are underway. Despite more disappointing US figures, the euro failed to capitalise and we doubt any eurozone releases will see the euro gain much ground. While we predict the single currency will remain on the back foot against sterling, it may stand more of a chance against the dollar if tapering doesn't begin this month. 

US dollar gets a battering 

The dollar took a beating last week, with sterling finishing off the job on Friday, pushing the GBP/USD rate to 1.5876. Poor US figures including non-farm payrolls figures and retail sales has contributed to the dollar’s downfall. The major driver of the greenback this week will be the outcome of the Federal Reserve meeting on Wednesday evening (7pm). A decision to reduce stimulus would see the US dollar rebound, while one to keep the asset purchase program on hold for at least another month could keep the currency vulnerable at least for this week. Dollar strength is mostly dependent on the Federal Reserve’s comments and actions. Even if the Fed decide not to go ahead with tapering this month it is still on the cards, and data from Wednesday onwards could be seen as another opportunity to warrant a reduction in stimulus to begin in October. For this reason we see the dollar remaining vulnerable for the earlier part of this week, with a slight window for strength as the weekend approaches.

End of week forecast

GBP / EUR	1.1950
GBP / USD	1.5855
EUR / USD	1.3275
GBP / AUD	1.7175

Sasha Nugent

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

Sterling rallies on BoE's "no QE" decision

The Bank of England has today decided against adding to its asset purchase facility (quantitative easing programme), which remains at £375 billion. The result has been some further support for the pound, so cleary there were some lingering suspicions that the MPC doves would do enough to persuade a majority to vote in favour of QE. The BoE base rate also remains at 0.50%, though this was universally expected.

Despite disappointing updates from the UK services and manufacturing sectors in the past week, the MPC was always likely to hold fire on the issue of further QE this month. The UK GDP figure for Q3 would have firmed up several MPC members’ positions and from the comments emanating from the committee, several members doubt not only the need for further QE but the capacity of the measure to actually make a material impact. In addition the BoE thinks that the 2.0% inflation target will be hit regardless of more QE, due to persistently high inflation.

Whether or not the BoE will decide that further QE is necessary in the coming months really depends on whether the recovery that was indicated in Q3 materialises. QE should be seen as an emergency measure and UK data has revealed a slight uptrend of late, so it really wasn’t necessary in the absence of any fresh shockwaves. If the debt crisis or the eurozone downturn drags the UK back into a triple-dip recession then there is little doubt that the BoE will once again come to the rescue. As it stands though, its case of wait and see how this recovery progresses. 

Richard Driver

Currency Analyst

Caxton FX

MPC minutes reveal a 7-2 vote to in favour of QE, where does the BoE go from here?

Yesterday’s release of the Bank of England MPC meeting minutes revealed a 7-2 vote to increase add £50bn of quantitative easing to the UK economy, taking the total of the BoE’s asset-purchase facility to £375bn. With the UK having entered a double-dip recession and showing few signs of a return to growth in the near future, the MPC understandably felt the time was right to give the UK economy another helping hand, particularly with external threats from a eurozone downturn increasing almost perpetually.

Expectations were pretty high for a unanimous vote in favour of the MPC’s July QE decision. However, for the first time since 2009, there was dissent when the majority voted in favour of QE. Dale and Broadbent both voted against the proposal on the grounds that there was sufficient stimulus in place. However, this less dovish aspect can be seen to be balanced by the additional discussion of the larger £75bn QE option, as well as a potential interest rate cut.

The decision was based on a fairly grim near-term growth outlook. The UK economy is struggling to emerge from its second recession in four years, and updated growth forecasts released by the International Monetary Fund earlier this week indicated that growth may be as low as 0.2% over 2012. This morning’s UK retail sales growth data for June came in well below expectations at 0.1%, while the PMI surveys from the UK’s manufacturing, services and construction sectors painted an overall very negative picture.

UK price pressures have also eased to a greater extent than expected over the past few months particularly; inflation is now at 31-month low of 2.4%. The minutes revealed that there was the consensus that more QE is necessary in order for the BoE’s inflation target to be met in the medium term.

The increased discussion and possibility of a cut to what is already a record-low interest rate of 0.50%, certainly did not go unnoticed. The minutes revealed that the MPC could review a possible interest rate change once the effects of its Funding for Lending Scheme (FLS) have been assessed. However, the effects of the FLS will not be ascertained for several months, so we can be confident that a BoE rate cut is not imminent.

So what about the MPC’s August meeting? It looks likely to be a classic wait-and-see meeting; waiting for the effects of the FLS and QE decisions to surface. In fact the MPC could remain on the sidelines until November, when the current round of QE has run its course. As ever, this comes with the caveat that negative eurozone developments are more than capable of accelerating the need for additional monetary stimulus.

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

Euro rallies on EU Summit, but the positivity is already waning

EU Summit far exceeds market expectations, fuelling euro rally

Market confidence in the build-up to last week’s EU Summit was pretty much at rock bottom. Angela Merkel’s continued tough stance on eurobonds seemed to indicate a wider deadlock between Germany on one side and struggling eurozone nations such as France, Spain and Italy on the other.

In the early hours of Friday morning, EU chief Herman Van Rompuy announced several decisions which gave risk appetite and market sentiment a major boost. Two key questions left by the Spanish bank bailout deal were answered. First, the bailout funds will be able to directly recapitalize Spain’s banks, without adding to the debt-to-GDP ratio of Spain as a whole and forcing its borrowing costs up. Second, the bailout loans will not be given senior creditor status, easing concerns that private bondholders will not see their investments completely written off. In addition, pledges were made that the bailout funds will be able to invest in
distressed bonds directly, again relieving concerns around the Italian and Spanish bond markets.

Clearly the markets were impressed by these decisions and they certainly buy some more time but they don’t amount to a silver bullet solution to the debt crisis by any stretch of the imagination. We still lack any detail on the fundamental issue of longer-term fiscal union and whilst the bailout resources can be used more flexibly now, though its size remains inadequate.

ECB and BoE both set to make moves this week

ECB Chief Economist Peter Praet stated recently that “there is no doctrine that interest rates cannot fall below 1 percent.” Comments such as these lead us to believe that the ECB is set to cut its already record-low 1.00% interest rate to 0.75%. There is a significant risk that the ECB will cut rates to 0.50%, in light of weak eurozone growth data and fading inflationary risks. Whilst the market is likely to be grateful that the ECB is taking action, the reduction in the euro’s interest rate differential is likely to be a negative for the single currency in the longer-term.

We expect the Bank of England to introduce further quantitative easing on Thursday, in light of the distinctly dovish tone within last month’s MPC minutes and the four votes in favour of QE that they revealed. Only one more dovish voter is required for a majority in favour of QE and we believe this will come on Thursday. The move looks to be fully priced in though, so sterling has already taken the pain in relation to this move. Wednesday’s UK services figure will be watched closely on Wednesday, a slowdown is expected.

The dollar has suffered a significant sell-off amid booming risk appetite in the aftermath of the EU Summit. We maintain a bullish outlook for the US dollar moving forward, although the week ahead brings with it significant risks. Friday’s US non-farm payroll is expected to show a mild improvement but amid the softness in US growth data of late it would be no surprise to see the result undershoot expectations.

The euro’s rally has already run out of steam; GBP/EUR is trading up above €1.2450 and EUR/USD’s has pared back from $1.27 to below $1.26. We continue to target levels well above €1.25 for sterling. A further decline in the EUR/USD pair will surely weigh on GBP/USD, which is coming up against stiff resistance around $1.57.

End of week forecast
GBP / EUR 1.2550
GBP / USD 1.54
EUR / USD 1.2475
GBP / AUD 1.57

Richard Driver

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

UK services sector growth solid and BoE holds fire on QE

This morning’s figure from the UK services sector was solid, coming in at 53.3, the same as in May but well above expectations. The figure is nothing to get too excited about but it is certainly a relief to see that the UK services sector remains firmly in expansion territory, even if the UK economy as a whole is contracting slightly.

One point to consider here is that these PMI surveys have lost a little bit of credibility given the positive surveys that characterised Q1, only for a -0.3% GDP figure to be announced. Nonetheless, the PMI surveys will remain significant as long as the MPC places such emphasis upon them.

Warmer weather and expectations for increased activity relating to the Jubilee and the Olympics helped stave off a services sector decline in May but weakness in the UK manufacturing sector remains the major concern with respect to the UK economy at present. Last week’s manufacturing PMI figure was very poor indeed.

The Bank of England’s monetary policy decision for June was announced at noon today, revealing a ‘no’ vote on further quantitative easing, for now. This morning’s UK services figure will have eased some of the pressure being felt by some of the MPC members to vote in favour of QE. Today’s monetary policy decision is likely to have been a closer call than in previous meetings. Judging by sterling’s rally in the aftermath of the decision, many market players had been suspicious of a June QE call over the past week or so. Nonetheless, we were not expecting them to pull the trigger again today.


The sounds out of the MPC just haven’t been dovish enough to indicate another round of easing was imminent, though the weak UK data over recent weeks arguably would have justified it. The MPC is probably holding more QE back as a fire extinguisher if the worst case scenario emerges from the eurozone debt crisis. The majority of the MPC seems content that the last round of QE is still feeding through and providing stimulus, they look happy to wait and see for now. In terms of inflation, the balances of risks on the medium term outlook remain equal, thus making any fine-tuning less attractive.

As ever, the minutes in a fortnight will be all-important – David Miles will clearly have voted for more QE and Posen is likely to have joined him, all eyes will be on the rest of the voters.

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 Queen’s Jubilee: Good or Bad for Sterling?

Now there’s no doubt that the people of the UK are welcoming with open arms the extra bank holiday that will be part of the Queen’s Jubilee celebrations. However, if we take the similar example of last year’s Royal Wedding, then we can expect a significant hit to the UK economy.

It is estimated that the Royal Wedding in 2011 weighed on the UK’s gross domestic product (growth) by 0.4%. An extra bank holiday means businesses are closed for longer - economic activity is reduced. Of course, there is likely to be increased spending on the high street and a boost to industries such as leisure and hospitality. This will certainly compensate for some of the impact on UK growth, but not all of it.

The Jubilee looks set to weigh on growth by 0.3 - 0.6% again this year, which is the last thing that the UK’s struggling economy needs right now. Data last week confirmed that not only did the UK economy contract for a second consecutive quarter but by even more than expected (-0.3% q/q). With the Jubilee set to constrain quarterly growth which was only ever likely to be flat at best, we can expect third consecutive quarter of negative growth.

What does this mean for sterling? Well, it won’t necessarily hurt sterling. After all, last week saw the release of some awful UK retail sales growth data, some much weaker domestic inflation data and a downward revision to the Q1 UK GDP figure. Regardless, sterling performed strongly, thanks to the ongoing focus on all things eurozone and the risk averse, sterling-friendly trading conditions this is creating.

Of course the risk remains that more negative growth will convince the MPC that more quantitative easing is necessary, but as yet the majority of the nine policymakers seem happy to let the last round of QE to feed through, particularly with medium-term UK inflation risks well-balanced and present inflation levels still elevated.

One common ‘silver-lining’ lining argument is that while the Jubilee may hurt Q2, the London Olympics are only just around the corner in Q3. Estimates have surfaced that the spending linked to the Olympics will boost UK GDP by 0.5%. We approach these predictions with a great deal of caution though, as do the Bank of England, since the impact and success of mega-events such as the Olympics are highly unpredictable. Sydney 2000 boosted Australia’s economy considerably, while Athens 2004 left the Greek economy crippled.

We maintain a positive view for sterling this year, except against the US dollar, regardless of stagnant/negative growth. Clearly the caveat here is that the picture may change if growth is so poor that the BoE pull the trigger on more QE – a major downside risk for sterling. Looking at the limited impact of the last round of QE on sterling though, there is a good chance sterling will hold up firmly again.

Richard Driver
Analyst – Caxton FX

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

MPC minutes reveal no extra doves but QE risks remain prominent

Wednesday’s MPC minutes revealed that David Miles remained the one and only policymaker in favour of an additional round of quantitative easing (£25bn) at the rate-setting committee’s May meeting. We have to admit that we expected one or two other policymakers to give Miles some company in the dovish camp, but we maintain that he won’t be the lone dove for long.

This much has been indicated by Adam Posen, who has been expressing second thoughts with regard to his decision to abandon his calls for QE, pointing to a potential overestimation of UK growth over Q1. We’d be surprised if Posen fall back to his dovish tendencies in June. Though it may take more than Posen to worry holders of sterling, given that a 7-2 split on the QE vote still keeps the dovish very much in the minority.

One major point that could dissuade several policymakers to vote for QE is the fact that they believe UK inflation is equally likely to be above target as below it in the medium term without more monetary stimulus. In addition, current CPI levels, regardless of the recent fall from 3.5% to 3.0%, are high.

Nonetheless, it was stressed that for several members of the committee, the decision was finely balanced and the option remains well and truly on the table. The latest figure from the UK retail sector, combined with the softer start we saw to Q2 in the form of some weak UK PMI surveys, will increase speculation that the UK’s struggling economy is in need of some extra monetary help.

The key factor that could well have the final say on the BoE QE debate is of course the eurozone debt crisis. The situation in Greece has taken a severe turn for the worse since the failure of the ruling coalition to secure sufficient support at its recent general election. A new round of elections is due on June 17th, which could well produce an anti-bailout collation and lead to a Greek euro-exit. Meanwhile, fault lines within the EU leadership have been highlighted this week in Germany’s rejection of French and Italian plans to introduce a common eurozone bond (a Eurobond).

As shown by the euro’s recent slide, confidence in the euro project is waning. We expect the euro-region to return to negative growth this year and the financial shockwaves from a probable Greek exit are expected to be worse than those of Lehman’s. Consequently, we bet we haven’t seen the last of UK quantitative easing in 2012.

Richard Driver
Analyst – Caxton FX

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

Greek coalition talks collapse and prospect of new elections hurts euro

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

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

Euro suffers from lack of Greek coalition agreement

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

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

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

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

End of week forecast

GBP / EUR 1.26

GBP / USD 1.5950

EUR / USD 1.27

GBP / AUD 1.61

Monthly Report: GBP/EUR and GBP/USD

Sterling has performed excellently in the past month, hitting fresh multi-month highs almost across the board. Some notably less dovish Monetary Policy Committee (MPC) minutes provided the trigger for a sterling rally in April, with the market subsequently betting against the likelihood of further Bank of England (BoE) quantitative easing (QE) - a key factor which has weighed on the pound over the past seven months.

The Office of National Statistics (ONS) last week announced the disappointing news that the UK economy contracted by 0.2% in the first three months of 2012. Taken with Q4 2011’s 0.1% contraction, this latest GDP figure signalled the UK having entered a technical recession. Nonetheless, sterling continues to enjoy strong demand as circumstances worsen on the continent.

The US dollar is still struggling to capitalise on its economy’s comparative strength. US growth data has fallen off its impressive uptrend somewhat, as shown by April’s softer unemployment figures and the recent undershoot in the first quarter US GDP figure.

This has played into the hands of the more cautious members of the US Federal Reserve, including Chairman Ben Bernanke, who refuse to rule out the possibility of another round of US quantitative easing. The market is becoming increasingly obsessed with the Fed’s monetary policy outlook and ongoing QE3 speculation continues to hurt the dollar’s performance.

The eurozone’s debt and growth situation is looking no better and worryingly, perhaps as a result of this lack of progress, the eurozone has become embroiled in fresh political uncertainty. French President Nicholas Sarkozy, could well suffer electoral defeat on the 6 May, whilst Greece will be holding parliamentary elections on the same date. Both elections could have significant ramifications on the direction of eurozone debt crisis in the short and long-term.

GBP/EUR

April saw sterling finally break away from the €1.21 level that had proven so sticky in the year to date. News out of the eurozone has been distinctly negative of late but unusually, the latest direction in this pair wasn’t predominantly euro-driven, but the result of much-improved sentiment towards the pound.

Economically, the situation in the UK remains extremely shaky. While April’s growth figures from the manufacturing, construction and services sectors were all encouraging and retail sales growth was staggeringly strong, the UK GDP figure for Q1 revealed a disappointing 0.2% contraction.

The market appears to be more than a little sceptical with regard to the ONS’s findings and will be looking for an upward revision to the GDP figure on 24 May. Regardless, the headlines surrounding a ‘double-dip recession’ are likely to weigh on consumer and business confidence alike.

UK suffers the double-dip

Whether or not the UK is indeed in a technical recession, UK growth will remain extremely weak in 2012. Disappointingly, Moody’s has recently placed doubt over the likelihood of any economic boost to the UK as a result of the London Olympics in the summer. The eurozone crisis continues to pose the greatest risk to the UK economy. As shown by the latest UK manufacturing figures, export orders are slowing and the eurozone’s economic contraction will undoubtedly drag on domestic activity.

The good news for sterling, however, is that its appeal is not based on economic growth potential. Sterling still represents a convenient alternative to investors looking to exit the euro but stay within Europe. Sterling is also a currency over which there is no threat of intervention looming (unlike the Japanese yen and the Swiss franc).

Despite the recent double-dip headlines, the UK government has reiterated its commitment to the austerity path, in order to maintain the faith of both the credit rating agencies and investors, thus keeping borrowing costs low. As a result, sterling’s ‘second tier’ safe-haven status has really come to the fore in the past few weeks and will provide plenty of support as the debt crisis rolls on.

MPC steps away from QE

Most importantly, sterling is now a currency over which there is perceived to be a reduced threat of quantitative easing, which contrasts particularly with the US dollar. The minutes from the MPC’s April meeting revealed that Adam Posen did not vote for additional QE, which took the market very much by surprise and left only David Miles as the solitary voter for additional monetary easing.

After a slight increase in UK inflation up to 3.5% in March, the MPC increased its medium-term inflation projections. The MPC’s apparent preoccupation with UK price pressures, over and above the state of UK growth, has seen bets on the likelihood of further QE from the BoE scaled back. With the MPC likely to remain in wait and see mode’ at its May meeting on 10 May, the pound has gone from strength to strength. Beyond this month though, there remain significant risks that the more pro-QE arguments will resurface to haunt the pound.

Downside risks to the euro

With regard to the single currency, events in the eurozone over recent weeks have certainly weighed on confidence, though not as much as one might expect. Growth data from Germany, France and the eurozone as a whole disappointed in April and another quarterly contraction is likely to be announced on 15 May. This will put the eurozone in the same boat as the UK - in technical recession. However, there’s no doubt the eurozone faces greater downside risks to growth than the UK moving forward and its recession is almost certain to continue through Q2.

Last month’s Spring IMF meeting failed to convince the markets that EU leaders have a proper handle on the EU’s ongoing crisis. The region’s ‘financial firewall’ has been bolstered by a further $430bn, which is a significant development. However, rating agency S&P has recently seen fit to downgrade eleven Spanish banks, which has seen Spanish and Italian 10-year bond yields make their way back up towards the dangerous 6.00% mark -a good bellwether of rising market tensions.

These rising tensions can largely be put down to fresh political concerns. 6 May brings the second and final round of the French presidential election. Nicholas Sarkozy is facing a likely defeat by Socialist candidate Francois Hollande, which places huge uncertainty over the EU’s Franco-German leadership, the EU’s fiscal compact and its ‘austerity first’ position.

Meanwhile in Greece, parliamentary elections threaten to prevent the country’s two leading pro-bailout parties from securing a majority, which again casts uncertainty over Greece’s bailout situation. In addition, the Dutch government’s collapse as a result of disagreements over austerity measures is telling of a growing political discontent across the region. There is a significant risk that the austerity backlash could spread to the UK local elections this week but the government is nonetheless unlikely to be derailed on its commitment to deficit-reduction.

GBP/EUR has climbed by over 2.50% in the past month, hitting fresh multi-month highs up to this week’s peak above €1.23 (the highest since July 2010). We are looking for further gains in the rate as conditions in the eurozone continue to deteriorate, with the €1.25 (80p) level representing the first key target.

GBP/USD

The US dollar remained soft in April, hemmed in by weaker US economic data and ongoing dovish rhetoric from US Federal Reserve Chairman Ben Bernanke. The monthly US jobs figure for March revealed that half as many jobs were added to the payrolls compared to February and US GDP data for the first quarter of 2012 came in at a disappointing 2.2% (annualised), against expectations of a 2.6% reading. Clearly the US economy is recovering at a far stronger pace than what we are seeing in the UK but it is the implications that this slower pace of growth (the US economy grew at a pace of 3.0% in Q4 2011) has with regard to the US Federal Reserve monetary policy.

The Fed was slightly brighter in its analysis of the US economy last month but is highly likely to remain in ‘wait and see mode’ for the foreseeable future. Bernanke has repeatedly put the brakes on any over-optimistic projections of US growth and has reminded the market that if the pace of US growth softens further from its current moderate pace and progress on the labour market issue stagnates, then QE3 is still very much on the table. Every time Bernanke emphasises the possibilities of QE3, the dollar sells off as risk appetite is boosted and investors chase higher yielding assets, such as the Australian dollar or stocks and shares.

The US dollar has found some favour in the past couple of sessions, helped by a stronger US manufacturing figure. However, a slide in the EUR/USD pair as a result of poor growth figures from the eurozone (Italy in particular) has proven more influential.

It has been difficult calling a top to the GBP/USD’s recent rally in the year to date. It must be said that with the recent poor UK growth figures in mind, doubts are likely to creep in with regard to the likelihood that the MPC will resist further QE this year. This may make this pair’s 8-month high of $1.63 a tough level to breach. We continue to anticipate that EUR/USD will fall through the $1.30 threshold this quarter and whilst sterling should hold up better against the dollar by comparison, a significant decline remains likely. Therefore, we are anticipating GBP/USD to ease back towards the $1.60 level, from the current rate below $1.62.

Richard Driver
Currency Analyst
Caxton FX

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

Less Dovish MPC Minutes Give Sterling a Major Boost

The recent release of the MPC minutes has given the pound an excellent boost. Adam Posen, the policymaker who has so often stood alone as the Bank of England’s arch dove, has seemingly abandoned his quest for further quantitative easing. Two votes became one in the MPC’s April meeting then, with only David Miles seeing fit to vote for a further £25bn in asset-purchases, though he stressed the decision was “finely balanced.”

The last quarterly inflation report assumed a fairly steady downtrend in UK inflation but the MPC is now noting higher medium-term inflation risks, which reduces the attractiveness of further QE. Higher inflation requires tighter monetary policy. For David Miles, the threat of a third consecutive decline in UK growth and another technical recession looms too large and he voted for extra £25bn of QE accordingly. Clearly, next week’s Q1 UK GDP figure will be crucial and the risks of another negative reading are not insignificant. However, April’s PMI surveys from the UK’s manufacturing, construction and services sectors were very encouraging and the recent UK labour statistics also provide room for optimism. The recent UK retail sales figure, which revealed stunning 1.8% growth in March, should ensure a positive GDP number on April 25th.

The BoE does appear to be moving away further monetary easing at present but the UK economy remains distinctly fragile. Many market players will be assuming further QE is now off the table but if inflation eases towards the end of the year and growth remains weak, dovish arguments will once again come to the fore. What’s more, the eurozone debt crisis could force the BoE’s hand if the situation in Spain and Italy deteriorates rapidly.

There is also the issue of Adam Posen’s thinking – whether he has really given up on more asset-purchases. Posen has indicated that he merely saw fit to let the current round of QE run its course. Posen will be able to reassess the need for a top-up in May, by which time the BoE’s inflation projections will have been formally updated and we will know whether the British economy has suffered the dreaded ‘double-dip.’ Only time will tell on this issue, but it’s fair to say the market may have jumped the gun in respect to Posen’s ‘change of stance.’ Our bet is that we will see Posen vote for more QE before the end of 2012.

Regardless, the majority of the MPC appear far too concerned with upside risks to inflation, and perhaps with preserving the BoE’s credibility on the issue of maintaining price stability, to step up QE at its next meeting in May or any time soon.

Whilst sterling’s safe-haven status has enabled it to weather the constant threat of QE hanging over it, it has undoubtedly weighed on demand in recent months. Sterling has now been freed up to rally in the aftermath of the minutes, climbing to a 20-month high against the euro and a six month high against the US dollar. Even higher levels will be seen against an increasingly weak single currency, though we maintain a negative outlook for the pound against the US dollar.

Richard Driver

Currency Anlayst

Caxton FX

EUR/JPY Overview: Japanese yen to continue weakening

The yen has weakened off by around 11.5% against the euro in the past two months. This is largely attributable to the convergence of performance between the US and Japan economies and monetary easing from the Bank of Japan.

The Japanese economy remains a key underperformer among the major global economies; it contracted by 0.2% in the final quarter of 2012 (though this was revised up from an initial estimate of a 0.6% contraction). Reduced exports, caused by the yen’s excessive strength and weakening global demand, are a key factor weighing on Japanese growth. However, industrial production and the post-earthquake reconstruction project is gaining pace, which should take Japanese back into positive territory this quarter.

The market was recently dealt a scare by January’s Japanese current account data, which revealed a record deficit of $5.41bn. The yen suffered as a result - Japan’s current account surplus has been a cornerstone of the JPY’s safe-haven status. Nonetheless, it remains likely that this deficit will prove a temporary blip, though it did the yen no favours in the short-term.

The US economy, by contrast, is outperforming. It grew at an annualised pace of 3.0% in the final quarter of 2011. As shown by the Non-Farm payrolls figures so far this year, the US labour market is making some real improvements. Crucially, this has seen the US Federal Reserve remove any reference to QE3 from its messages and in a statement this week, it upgraded its economic outlook from “modest growth” to “moderate growth.” With China slowing down, the eurozone entering a recession and Japanese growth likely to be fairly flat this year; the US economy is the real outperformer at present and we are seeing considerable yen to dollar flows as a result.

Another key factor weighing on the JPY is the Bank of Japan’s commitment to yen-depreciation. The strong yen has been a huge downside factor on Japanese exports. The Bank of Japan has repeatedly failed in its attempt s to directly intervene in the currency markets but monetary easing is still a weapon that the market is wary of.

February saw the BoJ boost its quantitative easing programme by 10 trillion yen, which has fuelled much of EUR/JPY’s gains in the past month. Whilst the BoJ took no further major action at its March meeting, the dissent within the committee highlights the scope for further easing. The Bank of Japan is highly concerned with the country’s deflation problem and is likely to continue monetary easing this year in order to achieve its 1.00% inflation target.

There are a plethora of reasons why not to invest in the euro this year. Having contracted by 0.2% last quarter, the eurozone’s growth figures in the year so far are pointing quite clearly to a recession. Nonetheless, there have been some broadly positive developments out of the eurozone in recent weeks, with the Greek debt-swap deal going through and paving the way for what is likely to be a second Greek bailout. However, sentiment towards the euro has been hit hard, as shown news by the 13.5% decline in the EUR/USD pair from last summer’s high.

Greece will be granted aid for now but it is widely expected to return to bailout territory by next year. Market sentiment remains suspicious that Portugal and more alarmingly Spain and Italy may be forced to follow a similar path in having to restructure their debt. The only real factor seemingly supporting the euro at present is the constant need of Asian and Middle Eastern central banks to diversify their FX reserves away from the US dollar.

Regardless of the eurozone’s poor growth and debt dynamics, monetary policy in Japan is likely to be the dominant driver of this pair in 2012 and EUR/JPY’s rise will not be a symptom of euro strength but of yen weakness. Long positions in the yen have fallen back considerably from January’s highs and we do not view the weakening bias we have seen in the yen in the past few to be temporary.

Developments in the eurozone and the US economy have provided a boost to global stocks, including the Nikkei, and in these risk-on conditions the safe-haven yen will always weaken. Events in the eurozone are likely to put plenty of pressure on market risk appetite this year but our bet is that the BoJ will successfully demonstrate its resolve in weakening the yen through monetary easing, something it failed to do through direct intervention.

We can see the EUR/JPY rate continuing its uptrend from the current 109.00 level in the coming months. This should see April 2011’s highs above the 120.00 level revisited at some point in the second half of this year.

Richard Driver
Currency Analyst
Caxton FX

Strong UK retail sales perfromance triggers hope of positive Q1 growth

January’s growth figure for UK retail sales came in at 0.9%, which is a staggeringly strong showing and well above forecasts of a 0.3% contraction. To put it into perspective, this figure represents the strongest monthly performance since last April’s Royal Wedding bonanza. On the back of December’s strong retail sales growth, this represents an excellent start to the year.

In terms of what products pushed this growth figure so high – January clothes sales were not responsible, rather it was fuel, sporting and household goods leading the way. The UK must be getting more health-conscious; food sales shrank and sportswear sales grew impressively. The hefty discounts seen on UK high streets are obviously being received well at consumer level but it doesn’t reflect well on UK shop-owners, who are quite clearly desperate to stay afloat. A recent report revealed that on average fourteen UK shops closed a day in 2011.

Discounts have obviously had an enormous role to play in the retail sector’s bumper month in January. However, lower prices will have played their part. Last year was characterised by soaring inflation caused by higher VAT, elevated commodity prices and a weak GBP, which saw UK CPI reach highs of 5.2% last September. However, inflation declined sharply to 3.6% in January, which gives an indication as to why UK shoppers stepped up their spending. UK CPI is expected to continue declining aggressively in the coming months, which will be a huge relief to British consumers.

Thursday’s nationwide consumer confidence survey provided an indication as to an improved high street sentiment. The survey jumped to a five month high but still, confidence levels remain at historically very low levels and no one saw this retail sales growth coming.

Nonetheless, the need for caution with regard to the near-term hopes for UK consumers is overwhelming. Household incomes continue to be tightly squeezed and wage growth has been minimal.UK unemployment is soaring and expected to rise further this year.

The UK economy shrank by 0.2% in the last quarter of 2011 and it must rebound into positive territory this quarter if it is to avoid falling into a second technical recession in the space of three years. Fortunately, the Bank of England’s additional quantitative easing appears to be working – January’s growth figures, led by the UK services and retail sectors, have been remarkably positive and a double-dip recession may just be avoided.

With tensions surrounding the eurozone’s growth and debt profile ever-increasing, the near-term outlook for the UK economy has rarely been more uncertain. If the crisis escalates further, the UK economy will be more or less powerless to avoid negative growth.

January’s rate of growth can surely not be sustained throughout Q1 but the unexpected upturn we have seen in recent weeks is welcome nonetheless. From a currency perspective, it has benefited the pound as well, GBP/USD is at a three-month high and GBP/EUR has recently tested a seventeen month high.

Richard Driver
 
Analyst – Caxton FX
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Moody's downgrades UK outlook but AAA remains intact

Ratings agency Moody's last night slapped the UK with a downgrade to its ratings outlook, doing the same to France and Austria. Moody's also cut the ratings of Italy, Spain, Slovenia, Malta, Portugal and Slovakia. Not the sort of news Europe was hoping to wake up to.

So what's the significance?

We don’t see Moody’s decision to downgrade the UK ratings outlook as overly worrisome. It is just a warning but all the warning signs were already there; it stands to reason that negative growth and climbing public debt will result in a loss of the UK’s AAA rating. Still, after the recent strong PMI figures and last month’s improved public borrowing figures, Moody’s warning will come as a bit of kick in the teeth. Nonetheless, UK debt has climbed over £1trn and the UK ecoonmy looks hard-pushed to grow its way out of trouble any time soon. The Q1 outlook for UK growth is fairly grim but we should see it pick up later on in the year as things stand.

The deciding factor will be developments in the eurozone - regardless of the UK government’s attempts to boost growth whilst cutting debt, if the eurozone crisis escalates then they will prove largely irrelevant. The liquidity operations have reduced the risks of a major collapse in the eurozone but the situation remains incredibly uncertain.

Greece has passed the necessary austerity package and has thus gone a step closer to receiving a second bailout that will avert a messy Greek default in March. However, further budget cuts need to be agreed, a debt-swap still needs to be agreed, and the Troika need to be convinced that Greece can implement its austeirty promises. All this and we face the uncertainty of a Greek general election in April, which inevitably opens the door to policy u-turns. On balance, the UK may just be able to hang on to its AAA rating, provided the European financial system buys enough time to shore itself up.

Sterling has taken the warning from Moody’s in its stride – GBP/USD came off a little last night but this was mainly EUR/USD driven and it has found support at $1.57 regardless.

€1.19 (84p) should hold firm for GBP/EUR, whilst GBP/USD should be able to climb a little higher in the short-term before we see a reversal.

This morning’s UK inflation figure has also failed to leave much of a mark, the market is well aware that prices are set to ease sharply in the coming months.

Richard Driver
Analyst – Caxton FX

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UK GDP points to recession and MPC minutes point to part of the solution

UK GDP figure disappointing

This morning was a big one for the UK economy and sterling. The UK GDP figure for the final quarter of 2011 came in at -0.2%, whilst the minutes from the MPC's meeting a fortnight ago indicated the BoE's QE programme will be expanded next month.

This morning’s UK GDP figure is certainly disappointing, but with sterling gaining after the release it is quite obvious the market was positioning itself for an even worse showing.

The UK's services sector has just about kept its head above water, but manufacturing and construction has been a letdown and the labour market is still in the doldrums. Yesterday’s IMF downgrade of UK growth prospects this year has certainly been vindicated.

The data clearly strengthens the argument that the UK economy is heading into tougher times. With the eurozone debt crisis likely to weigh on European and domestic growth for many more months to come, the UK looks likely to enter a technical recession.

So how can UK growth be boosted?

Well, the Bank of England is already trying to do so through its 275B quantitative easing programme. Today's MPC minutes reveal that the nine-member committee is ready to step it up again next month.

Adam Posen will be feeling particularly smug right now - he has staked his reputation on the UK economy's need for more QE and his colleagues in the MPC have had to come round to his way of thinking.

It was no surprise to see all nine policymakers voting to leave the current QE programme on hold. February has long been earmarked as the month to step up asset-purchases. High inflation looks as if it will no longer be an issue in 2012 (UK inflation dropped from 4.8% to 4.2% in December alone); the UK economy needs more from the Bank of England printing presses.

However, it does not look as if a decision to expand QE next month will be unanimous, the minutes include comments such as- "the risks to inflation were more finely balanced and it was less clear that inflation would fall below the target in the medium term." The risks of UK inflation undershooting the BoE's 2.0% target are a key motivation for QE. Nonetheless, this morning’s poor GDP figure highlights the UK economy's dire need for help and we still bet this will come in February. .

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