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

February Currency Outlook: GBP, USD, EUR

February 2013 Corporate Report:  Sterling friendless

January was another rough month for the pound, against almost every major currency, and the coming weeks do not look likely to be particularly fertile for a recovery. Sterling has been among the poorest performing currencies in the market, with a wide range of concerns over the UK economy weighing heavily. There are risks of a triple-dip UK recession, which in turn raise the probability of further quantitative easing from the Bank of England and a loss of the UK’s AAA credit rating. Until UK growth shows some signs of a recovery, the pound is likely to remain under pressure.

The euro’s remarkable rally continued in January, helped by further market calm in the eurozone and subsequent improvements to global market sentiment. ECB President Draghi gave the euro plenty of support by quashing speculation that his central bank would opt to cut interest rates (watch out tomorrow for further rhetoric). This optimistic approach has actually been bolstered by significant improvements to German economic data, even if growth in Italy, Spain and France remains very weak indeed. It only takes one look at bond yields in Italy and Spain to realise that nerves towards the debt crisis are at a low ebb and that confidence is pretty stable. That said, the past week has seen tensions rise ahead of Italy’s election this month.

Other than against the euro, the US dollar is also in pretty good shape. However, the recent weak US GDP figure for Q4 2012 hasn’t done the greenback any favours and will play into the hands of Ben Bernanke and the other dovish leaning policymakers within the US Federal Reserve. Positive sentiment towards the euro looks likely to limit the dollar’s gains in the coming weeks, but we still expect the USD to have a strong 2013.

GBP/EUR

Triple-dip fears dog the pound

Sterling is hugely out of favour at present; depreciation was so drastic in January that sterling’s trade-weighted index dropped by the most since February 2010. Economic weakness, speculation of more UK monetary easing and a more general loss of faith in the GBP as a safe-haven are all issues which have weighed heavily. The warnings as to a UK debt downgrade have been understandable and whilst predicting the timing of a downgrade is tricky, it would surprise us if the move was delayed beyond June.

Does sterling really deserve the battering it has received? Well, it certainly deserved some punishment; negative growth and a lack of progress on the UK’s debt situation are always issues likely to make themselves felt on the exchange rates.

There remain some brighter spots within the UK economy; the Funding for Lending Scheme appears to be bearing some fruit - bank lending is on an uptrend. The UK labour market continues to defy the wider domestic downturn. However, these rare good news stories have been of little use to sterling, with investors questioning how positive these factors can really be if they are not resulting in any genuine economic growth.

Unfortunately it’s quite clear that it will not be a particularly robust start to 2013, thanks to January’s snowy weather. The truth is that last summer’s Olympics concealed very weak underlying growth, which will become even more apparent over the rest of Q1. Sterling has at least been granted the relief that the UK services sector returned to growth in January but the risks of a triple-dip recession are still finely balanced.

Despite weak growth, we do not expect the Bank of England to opt for another dose of quantitative easing at its February meeting on Thursday, with most members satisfied with the Funding for Lending Scheme as an alternative to QE. David Miles is likely to remain the only voter in favour of QE in the February 7^th meeting; we expect the MPC under Sir Mervyn King to continue opting against further easing.

What will be more interesting on February 7^th will be Mark Carney’s appearance in front of the Treasury Select Committee. The market will be watching very closely for clues as to how Carney, who will take over from King as BoE Governor on July 1^st, will approach monetary policy. Unlike King’s comparatively hawkish doubts over the efficacy of more QE, Carney has been vocal on the utility of further easing and has pointed to other “unconventional instruments” which suggests he will strike a more dovish tone on Thursday. This is unlikely to be good news for the pound.

Germany perks up to help the euro

Once again, it’s been fairly quiet on the eurozone front, which has been a major factor behind the ongoing gains being made by the euro across the board. The weak investor sentiment towards the eurozone that characterised so much of 2012 is being unwound, as the risks of a eurozone break-up recede.

German data has been particularly encouraging in recent weeks with forward-looking sentiment and confidence surveys hitting multi-month highs. Still, the PMIs out of the eurozone as a whole continue to point to further economic contraction, which should lead to euro-weakness later on in the year. However, at present the market appears content to overlook awful growth and celebrate the signs that the worst of the debt crisis is behind us. This is really why GBP/EUR’s decline has been so aggressive.

There is evidence of burgeoning political tensions in the eurozone. Italy’s elections are scheduled for February 24-25 and considerable uncertainty lingers with respect to the outcome, particularly with the latest polls suggesting that Berlusconi is closing the gap. In addition, there is scope for Berlusconi’s PdL party to block the governing coalition’s laws in the upper house. Elsewhere, there are calls for Spanish PM Rajoy to resign after having been embroiled in a corruption scandal. This could potentially derail Spain’s reform programme and damage the stability we have seen in peripheral bond yields.

On the monetary policy front, ECB President Draghi has been very helpful to the euro, sending strong signals that he will not elect to cut interest rates once again, regardless of weak eurozone growth and record-high unemployment. Also propping up the euro has been Draghi’s refusal to express concern at the euro’s impressive rally to 15-month highs against the pound and US dollar. Euro bears will be watching this Thursday’s press conference very Draghi closely for signs that he is uncomfortable with the euro at current levels. We suspect they may be disappointed.

Sterling has depreciated by around 6.0% from where it started the year (marginally above €1.23). Amid the ongoing anti-sterling sentiment that is still simmering away, we don’t expect that this pair’s trough of €1.1470 will be as low as it goes. If Draghi sounds in confident mood on Thursday, we’d expect the downside to be tested once again in the coming weeks, with significant risks of a move down to €1.1364 (88p). However, we do expect this pair to bottom out soon and remain confident of a sterling recovery thereafter.

GBP/USD

Dollar flexes its muscles despite stalling US growth

The news out of the US economy has been typically mixed over recent weeks and there was no real change in stance from Ben Bernanke and the US Federal Reserve as a result. The fourth quarter US GDP figure for 2012 actually confirmed a surprise 0.1% contraction, rather than the modest 1.1% growth that was expected. In addition, the US unemployment rate jumped back up to 7.9%, which considering Bernanke’s obsession with bringing the jobless rate right down before ending QE3, was not good news for the US dollar.

The market has been correct not to panic at the US economy’s weakness at the end of last year, much of which can be put down to the effects of Hurricane Sandy. The Fed was clear that it was a case of growth pausing as opposed to it representing the beginning of another dip back into recession.

The GBP/USD pair’s sharp decline in the year to date has finally started to reflect the contrasting conditions and outlooks for the UK and US economies. Whilst the US has suffered some temporary weakness, 

underlying growth is still in decent shape and this will continue to be the case in 2013. The UK, by contrast, did not grow in 2012 and will struggle to eke out much growth in 2013.

An interesting theme over recent weeks has been the US dollar’s strong performance against currencies like the GBP, despite its extreme weakness against the EUR (EUR/USD climbed to a 15-month high only last week). We are already seeing concerns over the political situation in Spain and Italy spark doubts over how much higher EUR/USD can go. If we see the downward correction in EUR/USD that we continue to expect, then we expect GBP/USD to suffer as a result. Sterling is struggling with weak domestic news as it is, without major euro-dollar flows adding further pressure. This may well be delayed until later on in the year but it would be no real surprise if it came sooner. 

We may see GBP make another attempt above the $1.57 level in February but we expect that would represent an attractive level at which to sell. This should signal another move lower and potentially take this pair to fresh 6-month lows below the recently hit $1.5650 level.

GBP/EUR: €1.14

GBP/USD: $1.55

EUR/USD: $1.3650

Bank of Canada deals the loonie a blow

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

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

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

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Outlook: UK GDP needs to be firm

Sterling kept out in the cold despite host of strong UK figures

It was a good news week as far as the UK economy was concerned last week. We saw some more positive UK labour data; the unemployment rate dropped 7.9%, which is the lowest seen in over a year. Meanwhile, there were four thousand less jobless claimants; the improvements being seen in the domestic labour market are being sustained far beyond what many had expected.

UK retail sales data was also stronger than expected last week, while the public sector net borrowing figure also revealed that the government borrowed the least in the month of September since 2008. The chances are that Osborne will still miss his deficit-reduction targets but things appear not to be as bad as once feared.

Another development last week, which should have been positive for the pound, was a rather less dovish MPC minutes than expected. There appears to be a clear dovish voice within the MPC, led by David Miles, but there is no doubt that there are plenty in the nine-member committee who doubt that the UK economy needs a further dose of quantitative easing. Better still for the pound was the skepticism of some MPC members that more QE would actually be of any real practical benefit. Mervyn King speaks this evening and will perhaps provide some further clues. UK inflation has dropped to almost a three-year low, which is not exactly supportive of the pound but it was quite surprising to see the market ignore last week’s slew of genuinely upbeat economic figures. This week brings the long-awaited preliminary UK GDP figure for the third quarter; a showing of 0.6% is the consensus expectation, which should give the pound some belated support.

EU Summit hardly set the market on fire

It won’t come as much of a shock to learn that last week’s EU Summit yielded little by way of ground-breaking progress on the eurozone’s various debt issues. Merkel even said herself that this wasn’t a Summit where decisions would be made, rather it would pave the way for decisions to be made in December. Headlines focused around the banking union, which is expected to come into being at some point next year, but there was little to get excited about. Market nerves continue to ease though, as demonstrated by declines in Spanish bond yields, despite the fact that we remain in the dark with respect to the timing of bailout request from PM Rajoy.

There is plenty of eurozone growth data to keep an eye on this week, with investors possibly most concerned with conditions in Germany. A key gauge of the German business climate was surprisingly weak last time around and Wednesday morning should shed further light on this issue.

The euro has made a soft start to Tuesday’s session; Greece has stated that a deal must be reached on a €13.5bn package of cuts by Wednesday night, while Moody’s has downgraded five Spanish banks. This has helped sterling climb half a cent above its 5 ½ month lows of €1.2250. EUR/USD has also fallen to $1.30, which should see plenty of euro-buyers return in the short-term.

Sterling has lost grip of the $1.60 level this morning, a development we have anticipated for a while, though we have had to be patient. It now trades at a six week low of $1.5990 and direction from here all depends on what happens to the EUR/USD pair. Our base line scenario is for further losses for both pairs this week.  

End of week forecast

GBP / EUR	1.2325
GBP / USD	1.5975
EUR / USD	1.2950
GBP / AUD	1.5675
Richard Driver Currency Analyst Caxton FX

What can we take from the RBA minutes?

Last night’s Reserve Bank of Australia minutes were unsurprisingly dovish given the downturn in Chinese and global growth over the past few weeks and months. The minutes explained the key drivers behind the central bank’s decision to cut interest rates at its meeting earlier this month. As well as slower growth in Asia, lower commodity prices and weaker domestic growth also topped the RBA’s list of concerns. The bank is now envisaging a peak in resource investment, sooner and lower than initially estimated.

An ongoing decline in coal coking prices is alarming the RBA and there are reports of early closures of older mines and low take-up of new resource projects. The mining boom has been a huge driver of Australian growth in recent years and these tell-tale signs of decline are bad news for the economy and the AUD as a result. Weakening demand from the eurozone is clearly taking its toll on Chinese growth and the knock-on effect is weaker demand for Australian commodities.

The RBA is also very concerned about the aussie labour market. We have had a decent Australian employment update this month but the unemployment rate has climbed up to two-year high of 5.4% and the central bank is anticipating a deterioration in the coming months, in no small more part due to projected mining sector weakness. The mining sector has masked underlying weakness in the labour market for a while now, the truth should now emerge. 

Australian Treasurer Swan indicated last month concerns over a fall in Australian tax receipts, while the Government is committed to returning to a budget surplus. The difference is being made up in budget cuts, which will also weigh on Australian growth in the coming months.

Amid all these downside risks to Australian growth and the noticeably dovish tone in these latest RBA minutes, we are expecting another interest rate cut at the RBA’s next meeting in November. October 24 brings a key quarterly Australian inflation figure but an upside surprise does seem very unlikely and the path should be clear for another rate cut. This leaves plenty of scope for AUD-weakness in the coming weeks and months. 

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

German confidence tumbles again, pointing to possible German recession

A monthly German survey, which covers around seven thousand firms, has been released this morning to reveal that German business confidence has declined for the fifth consecutive month. A flat reading was expected but German business confidence has now dipped to its weakest level seen since March 2010. The news provides further evidence of the dampening effects of the eurozone debt crisis on the region’s powerhouse economy and has accordingly weighed on the single currency today.

Firms in manufacturing, construction, trade and industry were mostly responsible for the poor climate reading, though retail and wholesale trade did improve slightly. The regional downturn is having a particularly noticeable impact on Germany’s exports to other eurozone nations. The economic weakness being seen in major nations like Spain, Italy and even France cannot be viewed in isolation; recessions are particularly contagious in a currency union like the eurozone and this morning’s data indicates that Germany is succumbing.

Interestingly though, an economist from the producers of the data - the Institute for Economic Research - has stated that German consumption remains robust despite a weaker labour market and therefore does not see a need for an interest rate cut from the European Central Bank. An interest rate cut would however weaken the euro, which could boost exports outside the eurozone, though this would require Germany’s preoccupation with high inflation to be set aside. The IFO economist did also note that the survey was taken prior to the positive decision from the German Constitutional Court earlier this month, the uncertainty surrounding which may be at least partly responsible for the unexpected decline.

The economic downturn is not just bad news for Germany but for the eurozone’s peripheral nations as well. If Germany enters recession, then it is going to be increasingly difficult for Merkel to justify and deliver the support she is pledging for struggling nations like Spain and Italy. With plenty more austerity measures still to come across the eurozone, the prospects for the economy as a whole and Germany by association, are rather gloomy. After Q2’s 0.3% GDP growth, Germany may avoid economic contraction in Q3 but the same is unlikely to be true in Q4, such is the downtrend that is in place. This is not to say that Germany is certain to enter a recession but the risks are very significant and it is looking increasingly likely, which is bad news for all concerned.

We may have seen some progress on the debt crisis in the last month or so but economically, the region is in very poor shape indeed, which is in part why we maintain a negative outlook for the euro.

Richard Driver

Currency Analyst

Caxton FX

Spanish bailout will come but not for another month

The newswires have today been full of speculation over the imminence of a Spanish bailout. The FT has reported this week that negotiations between Spain and the EU are going places. The two parties are working on an economic reform programme which is rumoured to be unveiled next week. Note though, this is only a prelude to a bailout request.  

What is Spanish PM Rajoy waiting for? Well, regional elections in the Basque country and Galicia are being held on October 21 and Rajoy is likely to wait until after that, as a bailout request before this date would more likely than not damage his Conservative party’s chances. This end of October period coincides with some major Spanish debt repayments and is probably as long as the market is willing to wait for some concrete progress.

There is something to be said for getting in early with a bailout request whilst bond yields are away from their record highs, so that Rajoy is in a better position to negotiate favourable bailout conditions. If Rajoy waits until the situation returns to panic mode, Spain’s creditors could have him over barrel.

Next Friday’s release of the Spanish banking sector’s stress tests could well spook the markets and send bond yields soaring up to 7.0% again but on balance we expect Rajoy to wait until late October, just in time for the ECB’s meeting in the first week of November. This leaves time for bailout conditionality to be ironed out between the interested parties.

We believe Rajoy will use the next month to try everything he can to achieve the best result for his country. He is under huge domestic political pressure by an increasingly angry and volatile population and cannot afford to be seen to sacrifice more than is absolutely necessary in return for a bailout. Everything should be in place by the end of October and until then, the euro is likely to come under increasing selling pressure.

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

Swedish Krona set for further losses

The Swedish krona continues to trade at impressive levels across the exchange rates. The krona has been boosted by an ongoing recovery in market confidence, driven in particular by some key breakthroughs in the eurozone. This confidence has fed into sustained appetite for higher-yielding currencies like the SEK.

The key development from Europe this summer has been the ECB’s pledge to provide unlimited bond-purchases for peripheral eurozone countries like Spain and Italy, whose soaring borrowing costs have been a major feature this year. The ECB’s pledge has already had a very positive impact on eurozone bond yields and has eased some of the more immediate concerns that the debt crisis may spiral out of control before EU leaders can react. The improved global sentiment has been given another boost by the German Constitutional Court’s approval of the European Stability Mechanism, which is to be the eurozone’s permanent bailout fund. While the issue of firepower is by no means solved, the eurozone’s ability to respond to Spain and Italy’s refinancing needs has certainly improved.

Sentiment towards the Swedish economy remains broadly positive, which isn’t surprising given the outstanding Q2 GDP figure released in late July, which smashed forecasts. 1.4% quarterly growth is probably more than most G10 economies can hope to achieve throughout 2012 as a whole. Domestic consumption remains in good shape and the Swedish export sector’s continues to stand up pretty well in the face of deteriorating growth and demand in the eurozone. However, there has been some recent economic weakness that may persuade many investors to give up on hopes for any further SEK rallies.

GBP/SEK Outlook

The situation in the UK has been fairly grim this summer, with data confirming that on top of Q1’s 0.3% contraction, the UK economy contracted by another 0.5% in the second quarter, with the extra Bank Holiday as a result of the Queen’s Diamond Jubilee weighing particularly heavily.

However, the UK economy is showing some solid signs of turning a corner in Q3. Industrial and manufacturing production data has shown some excellent growth, the UK services sector bounced back in July, while the latest trade balance and labour statistics have also been very positive. Thanks in no small part to the London Olympics, there is now a decent chance of a positive Q3 GDP figure, which should result in some support for the pound.

Also supportive of the pound is the near-term outlook for Bank of England monetary policy. The BoE appears content to sit it out and wait for the effects of both its Funding for Lending programme and its last QE top-up, before easing monetary policy any further. Conditions in the eurozone have eased up, while domestic activity has improved in the past couple of months, which should ensure there is no more QE until November at the very earliest.

There is no doubt that the Swedish spent Q2 in rude health but there have been some mildly concerning figures released of late. August saw a surprise rise in unemployment to 7.2% from 7.0% and a very weak manufacturing growth figure, while the latest industrial orders data suggests there could be some further weakness down the line. However, it was weak Swedish inflation, not tame growth figures, which prompted the Riskbank to cut its base rate by 0.25% to 1.25% in September.  While Swedish krona’s interest rate differential has now been eroded, the market’s response was quite muted.

This pair posted fresh multi-month lows in the past fortnight, amid a series of positive eurozone developments. However, support levels have kicked in at 10.5, which has coincided with stronger UK figures and a slight loss in momentum in Sweden. These factors should combine to send GBP/SEK pair higher off these current lows in the coming month. 10.7-10.8 is a decent target area.

Richard Driver

Currency Analyst

Caxton FX

Swiss National Bank holds firm on EUR/CHF floor

Away from the wild speculation surrounding the US Federal Reserve’s meeting this evening and away from the strides being made in the eurozone, the Swiss National Bank gave its quarterly monetary policy assessment this morning. As expected, the SNB kept interest rates on hold in the 0-0.25% band. Slightly more interesting than this, however, was the SNB’s decision to reiterate its commitment to defending the EUR/CHF floor (or ceiling if you prefer to look at it that way) of 1.20.

Since the escalation of the eurozone debt crisis, the safe-haven franc attracted huge investment and the excessive appreciation that this caused was damaging to the Switzerland’s economy. In August 2011, the Swiss National Bank responded by intervening in the currency markets to weaken the franc (put simply, buying lots of euros and selling lots of francs). In September 2011, the SNB set a floor for the EUR/CHF exchange rate, pledging to use all the resources at its disposal not to allow the franc to strengthen past this point (below a rate of 1.20).

Since September 2011 then, any dip below the 1.20 threshold has been fleeting and marginal, but the market has certainly tested the SNB’s resolve. Central banks currency intervention is historically very unsuccessful and expensive, just ask the Bank of Japan. Up until now though, the SNB is doing a remarkably good job but only time will tell. 

Swiss National Bank's statement this morning has told us that they expect the Swiss economy to grow by 1.0% this year, down from the 1.5% growth they expected three months ago (though this is still a decent pace of growth). In addition, the SNB also sees consumer prices falling by 0.6%, more than initially expected, with inflation expectations for 2013 and 2104 also downgraded. 

In light of downgraded growth and inflation expectations, the SNB was quite clear on its on-going commitment to maintain the EUR/CHF floor this morning, stating that “If necessary, it stands ready to take any further measures at any time.” It’s not surprising either, the swiss franc remains overvalued. With near-term risks to Swiss growth high given the poor growth outlook for the eurozone economy, the SNB is likely to maintain its defensive stance in the medium term. However, talk of shifting the floor even higher up to 1.25 looks unlikely to be realised, as the SNB will probably view this as too risky. 

Richard Driver

Currency Analyst

Caxton FX

The German Constitutional Court gives the euro another boost

After weeks and week of delay, Germany’s top Constitutional Court has ratified the European Stability Mechanism - the eurozone’s permanent bailout fund. The court ruled that the ESM does not conflict with the German constitution and Italian PM Mario Monti has today stated that this “has removed the last obstacle for the implantation of the ESM treaty and the fiscal compact treaty.”

There are a few ‘buts’ though, which probably means Monti is jumping the gun a little. Whilst the ESM treaty does oblige the German government to contribute €80bn up front and further contributions upon bailout requests down the line, the German court has limited Germany’s contribution to €190bn. This is a significant condition and may prove to be insufficient given the refinancing needs of Spain and Italy. Italy could potentially decide to it is unable to contribute to the ESM due to the state of its own finances - Germany is unlikely to step willingly into the void. In addition, the court rejected granting the ECB a banking license and in doing so highlighted a continuing lack of firepower.

However, Germany's liability could be increased with the approval of the Bundestag, though such approval seems unlikely given the momentum of bailout-fatigue sentiment among the electorate. Another condition was included that both German House of parliament must be kept informed of ESM decisions, which does have the potential to delay future decisions.  

The ESM’s governing board will meet in early October for the first time but Eurogroup head Juncker has said it will not be activated before January 1, 2013. The euro has rallied again today, focusing on the disaster that was avoided rather than the considerable issues that remain. The euro may be to climb a little further on the back of a QE3 announcement tomorrow evening but it is fair to say this rally is looking increasingly overextended. 

Richard Driver

Currency Analyst 

Caxton FX

UK trade deficit narrows to an 18-month low

Trade balance data for July has revealed this morning that the UK trade deficit has narrowed to a February 2011 low of 7.1B. This was lower than the 8.9B deficit that was anticipated and significantly lower than the 10.1B deficit shown in August. 

At 9.0%, overall export sales growth was at its highest level since 1998. Sales of goods outside the eurozone grew by 11%, while somewhat surprisingly, sale of goods to the eurozone even grew by almost 8.0%. More positive news for the economy, then, and it certainly takes some of the considerable pressure off the UK government.

It is encouraging to see UK businesses respond to the challenges facing them, in the form of low confidence and deteriorating economic conditions in the eurozone, by diversifying their global trade relations. Increased take-up from the US, Asia (especially India) and South Africa all contributed to this morning’s improved figure. Oil exports to the eurozone was also a key factor in helping the July trade balance bounce back from June’s disappointing showing, which was the worst since modern records began 15 years ago.

Once again this points to a rebound for UK GDP in the third quarter. Awful trade balance figures were a real drag on growth last quarter, which unless we see another dramatic reversal in August and September, will not be the case in Q3. It goes without saying that this figure does not change a very uncertain outlook for UK exporters. The flow of bad news out of the eurozone has been stemmed somewhat over the summer but for as long as the region’s economy contracts, a cloud will remain over many UK businesses. Nonetheless, this is again good news for the UK and no doubt Chancellor George Osborne will sleep a little easier tonight.

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

More good news flows from the UK economy as industrial and manufacturing production picks up

Data this morning has revealed further encouraging news from the UK economy. The figures show that manufacturing production grew by 3.2% in July, while UK industrial production grew by 2.9%, which represents the strongest monthly improvements in 10 and 25 years respectively. While we remain in a double-dip recession, such improvements take on a greater importance and should be celebrated.

Naturally though, the data on its own does not tell the whole story, as July’s figures come on the back of an extremely weak performance in June. Nonetheless, the figures far exceeded expectations and undeniably point to a decent start to the second half of the year in those sectors.

There is no doubt that the UK manufacturers have plenty of tough times ahead, with economic conditions in the eurozone deteriorating. Only yesterday, the ECB downgraded its GDP forecasts. In June the bank saw eurozone GDP for 2012 falling in a range of -0.5% to 0.3%, now its sees it falling somewhere between -0.6% and -0.2%. The bank also foresees a significant risk of another economic contraction in 2013.

In this environment, it is difficult to see UK manufacturing and industrial production being a major driver of UK growth in the year ahead. However, there are signs that the sectors can maintain a mild uptrend, which is something to be thankful for. It could well help the UK bounce out of recession in 2013. 

This should dampen concerns surrounding the Organisation of Economic Cooperation and Development’s latest prediction that the UK economy will contract by -0.7% this year. Combined with the strong UK manufacturing and services sector PMI’s for August, improvements in the labour market and retail sales, Q3 looks to have started very well with the help of the London Olympics. This is good news for sterling, as the Bank of England may well decide not introduce any further QE when it next properly considers the option in November. 

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
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The aussie dollar is flying high but where does it go from here?

Australian dollar has gained by over 6.5% over the pound in the past two months, strengthened by nearly 7.5% against the USD in the past six weeks, and hit fresh record highs against the euro only this afternoon. The Reserve Bank of Australia cut its interest rate to 3.50% in early June and its key trading partner China continues to slowdown, so what is driving this latest rally in the aussie dollar?

One major factor fuelling the current positivity towards the AUD is the development that the German central bank, the Bundesbank, is set expand its portfolio of Australian assets. The eurozone crisis has caused central banks all over the world to review their reserve allocations and among others who are set to invest in Australian assets is the Czech central bank. This factor has completely overshadowed any dampening effects you might have expected as a result of the collapse of risk appetite that saw many higher-yielding currencies and equities decline since early May.

In addition, Australian economic data has in general held up remarkably well given the decline being seen in the Chinese economy (Chinese GDP has slowed down from a pace of 9.5% to 7.6% in the past year). Recent data revealed that Australian GDP expanded by an impressive 1.3% in Q1 of this year, well up from Q4 2011’s figure of 0.6%. This domestic economic strength gave the Reserve Bank of Australia the confidence not to cut its interest rate again in July.

However, we are seeing considerable risks of a rate cut in August as this domestic performance looks unlikely to persist. Recent Australian data has taken a downturn, particularly in terms of the domestic labour market. As well as July’s weak labour numbers, forward-looking indicators point to further softness.

Importantly, data revealed a sharp drop in Chinese imports from Australia in June and weekly New South Wales coal shipments have also fallen off this month. Equally, Chinese steel production has declined and its iron ore inventories have climbed, suggesting waning demand for aussie exports in the months ahead. As well as further deterioration in Chinese growth, we take a gloomy view as to the outlook for global growth and financial conditions, driven not least by eurozone risks. If a rate cut doesn’t come in August, we would be very surprised if it didn’t come in September.

For these domestic and international reasons, we see the AUD rally halting soon. AUD/USD should fail to sustain any breach of 1.05 and we should see this rate head back down toward and below parity in the coming months. In terms of GBP/AUD, downside scope is looking increasingly limited. The aussie is deep in overbought territory and we expect 1.55 will be seen once again before long. In addition, when the aussie dollar does endure its downward correction, it could well be quite a brutal move.

Richard Driver
Analyst – Caxton FX
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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
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Caxton FX Weekly Round-up: Euro takes a hammering

ECB cuts rates and the euro takes some punishment

The ECB met expectations last week by cutting the eurozone interest rate to 0.75%. In addition, the deposit rate was cut to zero. This all makes the euro the second-lowest yielding currency in the market after the swiss franc, which is likely to see investors increase their use of the euro as a funding currency for carry trades into higher-yielding currencies. This should be a major factor weighing on the euro moving forward.

For many, the ECB’s rate cut did not go far enough in offering support to the eurozone’s deteriorating situation. There is a significant chance of another interest rate cut at the ECB’s next meeting in August, as there is of alternative easing measures such as another LTRO (cheap loan offering).

The post-EU Summit optimism has well and truly run its course and the market sentiment has once again turned negative. Spanish bond yields are back up at 7.0%, while global equities have tumbled for three days straight. Eurozone investor sentiment data was very poor on Monday morning and with the market already reflecting on recent weak data from the US, Japan and China, the euro has come under some pressure.

It is not all bad news for the euro, however, as we have heard today that Spain will be granted a year’s grace until 2014 to meet its deficit target of 3%. This has been insufficient to trigger any major euro bounce, which is sitting close to 3 ½ year lows against the pound and 2 year lows against the USD.

US data spooks market and risk aversion takes hold

The key monthly figure from the US labour market disappointed last Friday. It is always interesting to see how the US dollar reacts to weak domestic data and Friday’s installment proved supportive of the greenback. Dollar-friendly risk aversion was the knee jerk response, despite the fact that the downtrend in US data is likely to push the US Federal Reserve into finally pulling the trigger with regard to QE3 later this year. There is a chance that the Fed will do so on August 1st and much depends on US data in the intervening period, but we suspect Ben Bernanke & Co will choose to keep their powder dry for another month at least.

The flight to the safety of the US dollar has seen GBP/USD lose some ground in the past few sessions. The Bank of England’s decision to inject another £50B of quantitative easing into the UK’s flat lining economy was broadly priced in, though last week’s poor growth figures from the UK’s construction and services sectors in particular were not helpful for GBP. The week ahead is fairly quiet in terms of domestic data, with only manufacturing production data and trade balance data likely to receive much attention.

EUR/USD was last week’s major mover, having tumbled from above $1.26 to below $1.23 in the space of just three sessions. We have been calling for a slide down towards and below $1.20 and this latest euro sell-off has only strengthened our resolve. GBP/USD fell as well, but not by as much (it fell from $1.57 to $1.55). This cleared the way for GBP/EUR to help itself to some easy gains up above €1.26. These are clearly strong levels at which to buy the euro in the short-term, though in the longer-term we target levels even higher in the direction of €1.30.

The market will look to the meeting of EU finance ministers over the next two days for a decision to activate the buying of peripheral EU debt but as ever there remains plenty of scope for disappointment here.

End of week forecast
GBP / EUR 1.2625
GBP / USD 1.5475
EUR / USD 1.2250
GBP / AUD 1.53

Richard Driver

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