Greece drives euro rally but US
fiscal cliff looms
Sterling was broadly unchanged across the exchange rates
through November, except unfortunately (depending on your exposure, of course)
against the single currency, where a significant decline was seen. We have seen
some progress from the eurozone in recent weeks, from Greece in particular. A
deal was struck to put the country’s debt on a more sustainable path, one that
could give it a realistic chance of emerging out of the current crisis, though
this is clearly many years away. Most importantly, the risk of a Greek exit and
euro break-up has receded – the key factor behind the euro’s latest rally.
There has been something of a dark cloud hanging over the
pound in recent weeks, caused by a mixture of negative UK data and pessimistic
growth forecasts from the Bank of England. This in turn filtered into
speculation that the UK could lose its AAA credit rating before long.
These factors haven’t stopped the pound from sustaining some
very respectable levels against the US dollar however. There has been a marked
improvement in growth data from the likes of the US, China and even the
eurozone in recent weeks, which in combination with progress in Greece has
lifted investor sentiment from a mid-November slump. However, with little
progress being made on the US fiscal cliff issue, the dollar could well bounce
back before the end of the year.
GBP/EUR
Sterling weak but downside limited despite
weak UK data
It has been a difficult few weeks for this pair. The Bank of
England brought the market crashing back down to earth with some pessimistic
growth projections in the aftermath of the surprisingly strong Q3 UK GDP number
(1.0%). Sir Mervyn King & Co have been very deliberate in managing our
expectations with respect to the UK economy’s performance in the final quarter
of the year, highlighting in the Quarterly Inflation Report that there are
significant risks of another contraction.
November’s UK figures certainly didn’t point to a very
robust start to Q4, with UK manufacturing sector growth contracting and the
services sector giving its worst showing in almost two years. We also saw the worst
UK claimant count update in over a year (after a very good few months it must
be said).
The recent public sector net borrowing figure came in worse
than expected thanks to tax revenues continuing to fall short, which painted a
grim picture of George Osborne’s deficit-reduction plan. With Moody’s Investor
Service having recently cut France’s AAA credit rating, many in the City are
speculating that UK debt will be dealt the same hand before long. There is a
high risk that one of the big rating agencies will swing their axe in the UK’s
direction in the coming months and this has left its mark on sterling.
It hasn’t been all bad news as far as the pound is
concerned. UK inflation ticked higher to 2.7% from 2.3%, which may have discouraged
one or two MPC members voting for QE in their November meeting. The minutes
from that meeting revealed that in fact only one voter, David Miles, was in
favour of extending the BoE’s quantitative easing programme. On balance, we do
not expect any further QE from the BoE, which should be supportive of the pound
in the longer-term. However, persistently weak UK growth is likely to continue
fuelling QE speculation. In addition, the MPC minutes appeared to remove the
option of an interest rate cut for the “foreseeable future.”
Greek disaster avoided
From the eurozone,
November was very much Greece’s month. With a deal being struck to avoid an
imminent default and bring Greek debt under some recognisable control, the
market may be able to put this particular eurozone worry on the backburner to some
extent. Nevertheless, there remains a high degree of scepticism towards
Greece’s ability to meet its targets and towards a lack of detail within the
agreement. We know that Greece will be granted longer to repay its debt and
that interest rates on that debt will be lowered. However, it is unclear how
the intended bond buy-back (at a discount) will be funded and when it will
occur.
Spain has this week made a formal request for its crumbling
bailout sector, which is a relief as far as the market is concerned. This isn’t
to be confused with a sovereign bailout though and Spain will surely be the
subject of the market’s cross hairs once again before long. We don’ think PM
Rajoy will be able to avoid requesting a full blown bailout, given the dire
state of economic growth and the still elevated borrowing costs that the
country is facing (despite recent declines). Any realistic analysis of Spanish
growth and debt dynamics over the coming years suggests that a bailout is
inevitable.
Concerns over the wider eurozone growth issue in the
eurozone have eased somewhat thanks to some recent updates. Germany and France
both showed unexpected growth of 0.2% in the third quarter, while Italy
contracted by half as much as expected (0.2%).
Nonetheless, we see nothing within the more forward-looking figures (despite
the recent upturn in the German business climate) to suggest the eurozone can
avoid a recession next year.
Sterling is trading at fairly weak levels around €1.23 at
present and we are sticking to our long-term and long-held view that this
pair’s upside potential outweighs its downside risks. Our hopes for a move
towards €1.25 by the end of the year remain intact and, more importantly,
realistic. In the short-term however, there is a strong risk of a move down
towards €1.2250.
GBP/USD
Sterling soaring against soft US
dollar, but for how long?
This pair’s downtrend has been interrupted in the past
fortnight by developments in Greece, which have had a very uplifting effect on
market conditions. The avoidance of a messy Greek default and euro-exit saw
global equities rally, weakening the US dollar significantly. The $1.60 level has
been recovered as a result but as ever we view sterling to be on borrowed time
above this psychological threshold.
The US economy continues to show evidence of a strong finish
to the year, demonstrated not least by the recent revised GDP figure for Q3,
which revealed an annualised growth pace of 2.7%. Consumer confidence continues
to climb and we are seeing the US housing and labour markets make further
strides.
With the Greek ‘can’ kicked down the road, focus through to
the end of the year is likely to be dominated by the US fiscal cliff issue. On
January 1st 2013, a series of sharp US tax rises and spending cuts
are scheduled to come into being, unless negotiations between the Democrats and
the Republicans bear some fruit in the coming weeks.
The fiscal cliff could as much as half US growth next year
and in doing so dent the global recovery considerably; the stakes are extremely
high. It is broadly for this reason that we expect US politicians to put some
sort of compromise together, in the same way we expected Greek negotiations to
produce a deal. Nonetheless, nervousness over this game of ‘chicken,’ which
could well go right down to the wire, is likely to lead to increased demand for
the safe-haven US dollar in the coming weeks.
Sterling is trading up at $1.61 level, which we view to be
an excellent level at which to buy USD. In our view, sterling is highly unlikely
to set fresh highs above this pair’s fifteen-month peaks in the $1.6250-1.6270
area. Sterling’s headroom is looking increasingly limited from here and we
expect a move lower in the weeks ahead.
Richard Driver
Currency Analyst
Caxton FX
