April 2013 Outlook: Sterling edges higher as debt crisis resurfaces

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

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

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

GBP/EUR

Cyprus has investors fleeing for safety

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

                            

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

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

UK Q1 GDP figure comes into focus

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

Dangerous precedents will hurt the euro

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

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

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

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

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

GBP/USD

Sterling finally enjoys a bounce

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

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

More improvements in US labour market

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

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

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

GBP/EUR: €1.20

GBP/USD: $1.53

EUR/USD: $1.27

Richard Driver
Analyst – Caxton FX

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Will the ECB cut interest rates next week?

Away from what’s going on in Spain and Greece, let’s take a look ahead at next week’s ECB meeting. This week’s key German business climate figure was awful and the significance of this will certainly not have been lost on the ECB. With economic contraction throughout the periphery weighing on growth in the eurozone’s powerhouse economy – will the ECB finally put its deeply engrained fear of high inflation to one side and give Germany and perhaps more importantly the rest of the eurozone a helping hand by lowering interest rates?

A German contraction in Q3 is not a certainty but it is now looking likely, particularly in light of the latest German confidence figure, which hit its lowest reading since March 2010. Spain’s central bank warned yesterday that its economy’s GDP continued falling at a “significant rate” in Q3, while S&P forecasted that Spanish GDP will contract by another 1.4% in 2013 and the eurozone economy a whole will achieve zero growth. With conditions so dire in Germany’s major eurozone trading partners, you don’t have to dig too deep to find motivation for a rate cut.

Domestic consumption, which accounts for around 60% of German GDP, is in good shape and consumer confidence remains stable. Admittedly, other domestic German indicators such as the ZEW and PMI surveys also suggested things are not so bad but we can probably put this down to temporary positivity triggered by the ECB’s bond-buying plan. The German business climate survey has built up a strong correlation with German GDP, which leads us to believe a Q3 contraction is on the way. Weak exports are likely to outweigh robust domestic demand.

Still, the ECB seems unlikely to cut interest rates next week. The ECB appears to have already factored in further weakness in eurozone growth; recently projecting a 2012 GDP contraction of between -0.6% and -0.2%. This latest poor figure from Germany probably does little to change the ECB’s approach. Indeed Draghi acknowledged a weaker business cycle in his September ECB Press Conference.

In addition, the ECB’s Nowotny has recently stated that he “sees no need to change interest rates in the eurozone currently.” ECB policymakers have also been lauding the positive response in the financial markets to the ECB’s bond-buying plan, suggesting they are satisfied with the 0.75% interest rate at present. Draghi will also be eager to keep the German ECB policymaker Weidmann on side by waiting until a rate cut is absolutely necessary, when German growth has completely ground to a halt and inflation has eased further. This is likely to happen later on in Q4, perhaps in December. The euro is certainly feeling the pressure at present but it will likely be spared the downside factor a rate cut for the time being.

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

US fiscal cliff a major danger to the US dollar

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

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

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

                                                                                                                              

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

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

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

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

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

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Outlook: further pain in store for euro

Spanish debt concerns drive GBP/EUR even higher

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

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

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

MPC minutes do little to hurt the pound

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

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

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

End of week forecast

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

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

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

BoE announces its Funding for Lending scheme, but how much impact will it have?

The Bank of England announced last Friday that it will start its funding for lending scheme in August, with £80bn being offered to banks at very little cost. The goal of the initiative is to stimulate economic growth through increased bank lending, which has remained constricted for several recession-hit years.

The Funding for Lending scheme follows a previous plan with similar aims called Project Merlin (2011), which was a ‘gentleman’s agreement’ between the BoE and the UK’s biggest lenders, RBS, Lloyds, HSBC and Barclays, to lend more money to small businesses and individuals. With lending actually reducing over the past year, Project Merlin has been dismissed as a failure. The difference in this new scheme comes in the way it is structured. With concrete deal terms and the opportunity for banks to receive considerably cheaper money from the BoE if targets are met, banks should be adequately incentivized to step up lending.

The money under the Funding for Lending Scheme will be offered to all large banks, with the cost of the loans based on their ability to continue lending. The cost will be dependent on its net lending between June 30 and the end of 2013. Banks that increase or maintain their lending over that period will pay 0.25% in interest. However, for every 1.00% fall in net lending, the bank will be forced to pay an additional 0.25% interest up to a maximum of 1.50% (still less than the current market price).

It is a measure of the economic quagmire that the UK finds itself in that this new scheme is being delivered in tandem with the Monetary Policy Committee’s decision to expand its asset-purchase facility (quantitative easing) by another £50bn.

The Bank of England’s figures show that the stock of bank loans to the corporate sector peaked in August 2008 at £517bn, but have since fallen by £95bn, a staggering 18%. The theory is that the availability of cheap loans may encourage some firms to take on loans in order to expand their business, especially those that were previously unwilling due to the high price associated with borrowing.

Of course there is some skepticism towards the scheme, the most notable being that banks may not pass on the cheaper lending, instead pocketing the cheap money, despite the higher costs that this would incur. Moreover, we are right to question whether withering bank lending is indeed a major factor behind the current recession. Is there really demand for loans? Are UK businesses really targeting expansion in the current climate? Or are companies just content to cautiously weather the storm and wait for friendlier economic conditions before they take on debt and with it, risk. Indeed the key drivers of the UK recession lie outside lending; the debt crisis and low consumer confidence to name just two.

Sterling responded positively to the announcement of the Funding for Lending details, with GBP/EUR spiking from €1.2650 to €1.2700, continuing the uptrend this pair has seen this month. Investors were clearly encouraged by the scheme with many believing that this could have a positive impact on the UK economy. Clearly events on the continent are of greater importance, GBP/EUR’s rise has much more to do with euro-weakness than with sterling-strength. Only time will tell whether the BoE’s new scheme will help UK growth pick up in the second half of the year – if it doesn’t you can bank on yet more QE. You can't blame the BoE for trying though, it must be seen to do something to promote growth, particularly amid rising extermal threats from the eurozone.

Adam Highfield
Analyst – Caxton FX
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Interest rate cut seems inevitable as the ECB looks to ease the debt crisis

The Governing council meeting of the ECB is set to meet in Frankfurt on Thursday and it is widely expected that it will produce the decision to lower its interest rate. It is a measure of the eurozone’s poor debt and growth dynamics that the ECB interest rate has already been cut to its current record low 1.00% level from its August 2008 level of 4.25%.

Clear indications have been made that the ECB is looking to cut the base rate. ECB Chief Economist Peter Praet has stated in the past week that “there is no doctrine that interest rates cannot fall below 1 percent…they (rate cuts) are justified if they contribute to guaranteeing price stability in the medium term." These comments followed others from another ECB policymaker who stated that a rate cut was an option that would be discussed in its July meeting. In light of this rhetoric, the market is rightly confident that another emergency cut will come from the ECB on Thursday.

A rate cut should come as no surprise given the prevailing conditions in the eurozone. Data this week has revealed that eurozone unemployment has hit its highest ever level of 11.1%. Growth data from the eurozone, including Germany worryingly, has been consistently poor and it is quite clear that the region had re-entered negative growth. Q2 could actually prove to be the worst quarterly growth performance in three years.

Eurozone inflation has also eased significantly this year, falling to 2.4% from the 3.0% level at which it ended 2011. Germany has always been obsessed with controlling inflation but even it must have softened its stance on loose monetary policy in light of the news that its domestic inflation rate eased more than expected to 1.7% last week.

There are plenty of doubts surrounding the impact of another interest rate cut. The Bank of England has decided not to cut interest rates despite entering a double-dip recession, precisely because of the limited impact that such a move would yield. However, a rate cut would translate into significant savings on the huge amount of loans that European banks have taken from the ECB over the last year.

There is the argument that a rate cut will actually undermine confidence as the ECB is seen to be desperately exhausting its options, but we reject this. Our view is that a rate cut will actually be welcomed as a piece of assertive action amid growing eurozone turmoil, though the reduction of the euro’s interest rate differential will stop this boost in confidence resulting in any material support for the euro.

It goes without saying that a rate cut will not solve the problem in the long term. The financial crisis in the Eurozone has come about due to structural problems, and as such, the solution must involve structural change. Lowering interest rates is not capable of fixing this crisis. In fact as ECB President Draghi has noted, long-term solutions to the debt crisis are in the hands of the EU’s political leaders, not its central bankers. The ECB can only really ease conditions in the short-term, as shown by the two rounds of cheap loan offerings in the past year or so (LTROs).

There are differing views on just how much Draghi & Co will cut the base rate by and the size of the cut is likely to impact on the market response. A 0.25% rate cut may not be enough to satisfy the market’s appetite for emergency measures. A 0.50% cut is possible but a quarter percent cut seems more likely, with the ECB declining the options of another cheap loan offering or bond-buying.

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

UK recession confirmed...and it’s worse than first thought

Data on Wednesday has confirmed that not only did the UK enter a double-dip recession in Q1 of 2012, but it contracted by 0.3%, rather than the -0.2% figure that was initially estimated April. At the time of the initial estimate in April, sterling was spared quite a bit of pain because the market thought it knew better than the Office of National Statistics (which releases the GDP figures). In particular, many questioned the ONS’ assessment of growth in the construction sector. Ironically, a downward revision to construction growth was largely responsible for today's headline.

The MPC was also a little guilty of overestimating UK economic conditions in the first quarter, choosing to focus on some more positive but ultimately misleading PMI surveys from the UK construction, services and manufacturing sectors. Indeed Adam Posen, for his part, has admitted as much.

What seemed like a bright start to the year had definitely fizzled out then and the UK economy is set to struggle for the rest of 2012, possibly contracting by 0.5%, as ongoing UK austerity kicks in and the eurozone crisis weighs on external demand, and internal lending and confidence.

Still though, sterling has weathered Wednesday’s downward GDP revision very well. There is very much a sense that the market is fully aware that UK growth will be stagnant this year, but at least it is getting its public finances in order, and as shown by the UK’s ultra-low borrowing costs, it is clearly removed from the threat of eurozone debt contagion. Sterling’s appeal isn’t based on the imminence of monetary tightening or a positive growth outlook. The pound is basically the poor man’s US dollar, a second tier safe-haven.

In line with a pessimistic outlook for Greece and regardless of the likelihood of further QE from the BoE and the UK’s vulnerability to eurozone developments, we have a positive outlook for sterling against the euro and other risky, commodity currencies like the AUD and ZAR. Clearly, our view is less positive against the US dollar – we see GBP/USD heading down to $1.50 in the second half of this year.

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

Euro vulnerable ahead of crucial eurozone elections

UK enters a technical recession but sterling still flying high

The preliminary reading of the UK’s Q1 GDP figure came in last week to reveal a 0.2% contraction, which triggered a wave of headlines regarding the UK economy having entered a double-dip recession. Still though, the pound is on the offensive across the board, which is really a reflection of its growing safe-haven demand.
There is widespread scepticism with regard to the latest GDP figure and many, including us, are expecting an upward revision towards the end of May. What’s more, the figure does little to change the Bank of England’s monetary policy outlook as the MPC had already recognized the risks of Q1 contraction and appear confident that growth will pick up this year. The UK government’s response has been to reaffirm its unwavering commitment to keep the UK’s international borrowing costs low through ongoing austerity measures - a popular stance with the market.

The UK’s monthly set of growth figures will roll out over the next few days and readings of the manufacturing, construction and services sector are expected to show a slowdown. Judging by the performance of sterling in the past fortnight though, next Thursday’s BoE quantitative easing decision represents the next major domestic risk event. The MPC is likely to remain in wait and see mode next week, regardless of the UK’s economic slump in the past three months.

US growth slows down to strengthen Bernanke’s dovish position

The first quarter US GDP figure came in at 2.2% (annualized) last week, well below the 2.6% reading that was anticipated. Whilst clearly outpacing the UK economy, this slowdown is playing into the hands of the more dovish members of the US Federal Reserve, particularly Chairman Ben Bernanke. Bernanke stated that US monetary policy is “more or less in the right place” at the moment and interest rate hikes aren’t expected for at least another couple of years. However, Bernanke has once again emphasized that the door remains well and truly open to a third round of quantitative easing and it is this factor that continues to hurt the US dollar.

This Friday brings the monthly US non-farm payrolls figure, the most important indicator of growth in the world’s leading economy. A weaker number is expected, so it is unlikely that the US dollar, in the short-term, will return to strength on the basis of domestic economic strength. However, the US dollar will remain a safe-haven target if eurozone nerves jangle again, as they may well do as the weekend approaches.

French and Greek elections come into focus

Eurozone jitters are likely to increase ahead of the weekend’s final French and Greek elections. Sarkozy’s rival Hollande is looking favourite to win the French presidential election, while there is chance that Greece’s two major parties (the current coalition) will fail to secure a majority. Amid this huge political uncertainty, we may well see the euro struggle this week.

Sterling is trading up towards €1.23 this week, which is the result of a 2.5% climb for this pair in the past month. Further gains for GBP/EUR look probable. Sterling is trading marginally off an eight-month high of $1.63, which is still an excellent level at which to purchase USD. There may be room for a little more upside in the short-term but a weaker EUR/USD should eventually drag on GBP/USD.

End of week forecast
GBP / EUR 1.24
GBP / USD 1.6350
EUR / USD 1.31
GBP / AUD 1.57

Richard Driver

Currency Analyst

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

UK unemployment data better than expected but hardly to be celebrated

Today’s monthly UK employment figures for November were seemingly encouraging, revealing far fewer jobless claimants than expected, whilst the UK unemployment rate avoided a further rise and remained at 8.3%. The UK now has 2.64 million unemployed.

Only three thousand people were added to the jobless list, against expectations of a sixteen thousand increase. This is positive but figures such as these do little to change the overall picture of a gloomy economic outlook here in the UK.

On the face of it, the figures suggest that the labour market may not be as bad as anticipated moving forward. However, we still believe conditions in the labour market will continue to deteriorate looking ahead to 2012.

Government austerity measures are taking their toll on employment numbers and will continue to do so for many months to come. The private sector is failing to pick up the slack left by private sector cuts and the picture for UK youth employment is looking very poor indeed, with the figure alarmingly up at 20%. Wage growth is also down, which is no surprise, but at least consumer inflation is coming down (down to 4.8% in November).

The risks of another UK dip into recession are ever-increasing and today’s employment numbers do little to indicate otherwise. UK households will remain under pressure over the next year and circumstances are could well worsen before they improve.

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

An unexpected bounce in the euro’s step

A successful Spanish bond auction helped ease some concerns about the debt crisis plaguing the eurozone’s most indebted nations and finally gave the market some interest and direction.

The euro hit a one month high against the Swiss franc and regained some ground against most of its counterparts following the news. News last night that Germany’s principal, Angela Merkel, may be willing to extend the EU’s relief fund helped to put investors mind at ease and the bond auction went through without a problem. Both the Portuguese and Spanish auctions were concerns at the start of the week, helping to suppress the single currency. However, with the US dollar’s weakness late in the session yesterday and the news of the Iberian sales going well, the 17 nation currency has appreciated to €1.19 and €1.33 against the pound and greenback respectively.

The outlook for EUR remains to the downside in the medium term however. With no plan set in stone and Southern Europe’s debt snowballing, one set of bullish data from the US could turn everything back on it head.

In other news, Timothy Geithner once again called for the People’s Bank of China to allow the yuan to appreciate. Its artificially low value gives China an advantage over the rest of the export market and makes American goods less competitive. However, it seems highly unlikely that the world’s second largest economy would give up such a strong opportunity to hunt down the ailing world ‘no 1.’

Should China do what is best for them or the world economy? To comment on this or any part of the blog please write a comment below.

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

Sterling is merely a spectator as the euro slumps against the US dollar

Despite worse than expected construction data from the UK, sterling has made gains against most of its major counterparts as it tracks the US dollar higher.

Positive employment data from the US and continuing fears about the eurozone debt crisis have sent the greenback higher with the pound hanging on to its coattails. A report showing that US companies created almost three times as many jobs in December than expected helped the US currency make its largest gains in almost three months. USD has recouped all losses made against the yen since new year’s eve and taken it back to pre-Christmas levels against the overinflated Swiss Franc.

Continuing issues in the eurozone will be the general theme for 2011 with a possible break-up of the single currency the most extreme prediction from some analysts (see this piece by Harry Wilson in The Telegraph). While this is unlikely, pressure from the stronger EU nations for a resolution could well lead to a state of greater fiscal union with Germany inevitably picking up the pieces.

Reading ‘Peston’s Picks’ from the BBC, I was interested to see his views on the Ipsos Mori survey published today. The survey outlines that FTSE 350 leaders are more upbeat about the start of 2011 than they were in 2010, despite heavy handed austerity measures. Mr Peston goes on to point out that despite muted optimism in early 2010, no one saw the collapse of Greece and Ireland (although according to this BBC piece his colleague James Robins, the BBC Diplomatic correspondent, did exactly that) . What will 2011 have in store for us?

In other news, further integration of China into the world economy took a leap forward as the World Bank has issued its first bond denominated in the Chinese yuan. The international lender could have plans afoot to make China its third largest stakeholder after the US and Japan.

And finally, pun’s about the state of the single currency reached fever pitch as Estonia has been enveloped into the EU’s economic bosom. Apparently, a cow in Tallinn, Estonia’s capital, offers an excellent exchange rate of one kroon to one euro, fifteen times better the actual exchange rate. Well, where there’s muck there’s brass! (sorry)
Tom Hampton
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

The euro in free fall

The euro has fallen to two month lows against the US dollar and sterling, hitting $1.3066 and €1.1891 respectively.

A confirmed bailout package of €85billion has not managed to sooth the markets fears over the state of the eurozone as a whole. The issue has escalated so far that the single currency has fallen below its 200 day moving average and the next key target is €1.30. Investors expect further losses given the uncertainty surrounding the fiscal outlook of the regions ‘peripheral’ countries. With the state of the economies of countries like Spain and Portugal, it is hard to see light at the end of the tunnel. To put things into perspective, Spain’s economy is twice the size of Portugal, Ireland and Greece combined. A bailout package for the Spaniards would make anything we have seen so far insignificant.

With very little out this week from the UK, all eyes will be on EUR/USD, with the UK currency a mere spectator. Look for any bad news results from the eurozone and Friday’s Non-Farm Employment Change figures. Having heard very little of the results of the South Korean’s and the American’s sea trials over the weekend, an escalation in problems over there will only have a negative effect on the 16 nation currency.

Tom Hampton

Analyst – Caxton FX

‘Hard road leads to a better future’

Just one of the chancellor’s quotes from today’s government spending review. The market seems to believe it does lead to a brighter future as sterling remains within range of where it was before George Osborne opened his mouth.

Despite the pound’s seesaw journey during this afternoon’s session in parliament, it has come out relatively unscathed. This either suggests that the market believes in what the government had to say, or, more likely, has already priced in the potential adverse affects (the other suggestion is that the review had little of any real substance!). The truth is probably somewhere in the grey middle. Most of the spending cuts had been accounted for. However, the crocodiles teeth I have been tracing for the UK currency against its peers on my screen for the past 2 hours tell a different story. If it was all priced in why was there so much volatility?

The truth is this: the next 18 months can go one of two ways. The bleakest view is for most of the west to suffer a double dip. A dire Q4 could put the UK back in recession with stubbornly high inflation and plenty of SME’s going under. It would be a long and slow road to recovery led by the east and a weak UK currency to try and boost exports.

The second scenario would be for the west to narrowly avoid recession with some economies following Japan into stagflation. The recovery would be led by the east (again), the UK’s austerity measures gain traction and market confidence grows, bringing foreign investment and inflates sterling.

Either way, we will see a series of troughs and peaks before we are out of the woods. With the government cutting costs to the tune of £81billion and a VAT hike on the horizon, the UK will be looking to private business to pull us through. The banks need to start lending again, however, with a banking levy on the cards, how likely is that?

Tom Hampton
Analyst – Caxton FX

The US dollar continues to flounder

The greenback has managed to claw back early losses as it sank to $1.5874 against sterling, $1.3641 against the single currency and a two year low against the Australian dollar.

The ailing dollar fell this morning as sliding US treasury yields and mounting fears of a second round of quantitative easing pushed the currency lower. With a continuous stream of weak economic data and Q4 predicted to be very slow globally, it’s beginning to look like the only thing that may shift focus away from the greenback would be a European nation defaulting on its debt (which is looking increasingly unlikely).

Sterling felt the full force of panic over potential monetary easing measures as Adam Posen, a member of the MPC, declared that the Bank of England may even need to go as far as buying up corporate debt to guard from the double dip recession.

In other news, the House of Representatives is poised to pass legislation to pressure China to let its currency appreciate more freely. A brave move by the Americans as the Chinese Central Bank holds over a trillion dollars in notes alone. A sell off of dollars from China could send the US currency into freefall (at least the US export market might help them through these dark days?).

Tom Hampton
Analyst Caxton FX

Is the euro’s ascent sustainable?

The single currency has risen from $1.1923 against the US dollar at the start of June to hit a 5 month high today at $1.3463.

The overwhelming feeling in the market is that these gains are unsustainable amid concern that nations on the region’s periphery will default on their debts despite their surprising ability to raise funds at recent bond auctions.

The euro’s recent rally over the past few days has pushed it back into overvalued territory against a backdrop of deteriorating fundamentals. With Ireland’s GDP shrinking by 1.2% in Q2 and bond rates moving towards the ever important double digit range, a default from a PIIGS nation remains a distinct possibility. Germany cannot support a whole continent forever. Europe’s only saving grace is that each country’s government has implemented austerity measures to try and rectify the situation; their only hope is that with a tough Q4 coming up globally, everybody else has a tougher time than them.

Keen readers will remember that yesterday, at an FX trends seminar the underlying trend for Q4, potentially into next year, is Swissie strength. You will see today that the Swiss franc is at a two and a half year high against the greenback having smashed through several key resistance levels to be hunting down parity. Another currency approaching a level playing field with the US dollar is the Aussie dollar. With continuing strong growth from the tiger nations and the commodity boom, the Aussie is going from strength to strength.

Have a good weekend

Tom Hampton
Analyst Caxton FX

Has Sterling bottomed out?

My screen is finally awash with green today as sterling pulls back some of its losses from the past few days against all of its major counterparts except the Swiss franc.

The pound is back up near €1.1750 against the euro having sunk to a four month low of €1.1672. Further doubt over the longevity of the European economic recovery spread as poor data showed growth in the eurozone slowed in September, causing peripheral bond yield spreads to widen against German counterparts. Against the greenback, the UK currency did creep above $1.57 earlier in the day. The dollar is continuing its fall from grace with concerns over further rounds of quantitative easing and yet more poor data showing that the amount of jobless claims unexpectedly rose last week.

Be warned, Sterling’s rebound could be a momentary correction as the pound was heavily sold on Wednesday. The UK economy remains extremely vulnerable as the BoE alluded to with the possibility of a fresh monetary injection.

In further news, I spent my morning at a seminar on foreign exchange trends, which was as interesting as it sounds.... The major themes to report for the middle to long term are;
A) A double dip recession (depending on your definition) looks an almost certainty for the US, UK and Europe, while Asia looks to be the engine house for the global economy.
B) The unstoppable ascent of the Swiss franc. The lack of support for the traditional safe US dollar has led risk averse investors to the franc and the Japanese yen. However, with the BoJ’s intervention to depress their currency, the Swissie has become the hedge of choice for many. Great internal economic fundamentals and global uncertainty in Q4 look set to send the franc higher.
C) Those of you looking for a higher-yielding asset may look to the Aussie dollar. Some analysts are saying that it is near the end of its run. However, with commodity prices at an all time high, insatiable demand from China and a high interest rate that is looking likely to be moved even higher, it has every potential.

Tom Hampton
Analyst Caxton FX

Sterling rebounds from early losses

Sterling touched a seven week low against the euro and fell against the dollar after a surprise rise in claimant figures fed concerns over the UK economic outlook.
Data released this morning showed the number of people claiming unemployment benefit rose by 2,300 in August. It is the first rise since January and went against expectations of a fall of 4,100. The rise comes as public sector departments begin redundancy programmes ahead of this autumn’s spending review. The figures confirm that the UK recovery is still in the balance, and despite the persistently high level of inflation, the Bank of England remains poised to act if the recovery starts to waiver.
In other news, the Japanese yen has tumbled over 3% against both the US dollar and the pound after the Japanese government intervened by unilaterally selling the yen to curb gains that threaten the export-led recovery. This was the first time since 2004 that the government had intervened.