Caxton FX Weekly Outlook: GBP/EUR/USD

UK GDP figure strong but reality check could be around the corner

Last week’s Q3 UK GDP figure beat expectations by some distance (1.0% vs 0.6%), which triggered plenty of sterling demand. The boost from the Olympics and the natural rebound from the extra bank holiday that weighed on growth in the second quarter suggest that the economy has recouped the 0.9% contraction that we saw in the first half of the year.

The much better than expected GDP figure is certainly good news but if we take a step back, the truth is that the UK economy has done little more than flat line in 2012 so far. Since the release, MPC members have been quick to manage our expectations for Q4. Indeed, we are likely to see some weak growth figures in the week ahead in the form of the monthly updates from the UK manufacturing and construction sectors, which threatens to knock the pound off its perch against the dollar in particular.

Despite the scepticism with which many are looking upon the GDP figure, we do see it as likely to convince the BoE not to announce another round of QE at its monthly meeting next week. Whilst there is clearly a pro-QE voice within the MPC, we just doubt that the doves will be able to form a majority next week.

US growth in better shape ahead of key monthly employment data

Friday brings October’s US non-farm payrolls figure, which is expected to show some further modest improvement. This, in combination with last week’s forecast-beating US GDP figure (which indicated that the US economy grew at an annualized pace of 2.0% in Q3) may well give global stock markets a lift, taking away some demand from the safe-haven US dollar. As things stand however, fears over Hurricane Sandy have instilled in the markets a distinctly cautious tone at the start of this week, which has kept the EUR/USD pair pinned down below $1.30.

The US dollar has certainly been on the ascendancy in the past week, as frustrations over a lack of progress in Spain and Greece have set in. The former country appears no closer to requesting a bailout, something which is clearly testing the markets’ patience by the look of rising Spanish bond yields. Also weighing on the euro last week were some very disappointing German economic figures – this weak growth story running behind the debt crisis is a key driver behind our negative outlook for the euro in the coming months. We have had some poor German employment data out this morning, which has been a source of concern, though the euro has been given a helping hand today by a positive Italian bond auction.

End of week forecast

GBP / EUR	1.2400
GBP / USD	1.5950
EUR / USD	1.2860
GBP / AUD	1.5550

Sterling is trading at €1.24 this morning and faces a difficult end to the week in the form of domestic growth data at the end of the week. We see EUR/USD paring back from its current $1.2950 level, which should help GBP/EUR fall no lower than €1.2350. We still fancy a move above €1.25 in the coming month or so, which could actually bring a move significantly higher into sight provided the BoE holds off from further QE.

GBP/USD’s rallies are running out of steam at early stages and a sustained move below $1.60 is still our best bet.

Richard Driver
Currency Analyst
Caxton FX

US GDP beats expectations but dollar fails to rally

US GDP data has impressed this afternoon, revealing that the world’s number one economy grew by 2.0% in the third quarter, ahead of market expectations in the 1.8 -1.9% area. This is just a preliminary reading but good news nonetheless.

A temporary surge in defence spending appears responsible for the figure’s stronger than expected showing, though this is unlikely to be sustained. What is good to see is that conditions in the US housing market are improving, as is consumer spending. We know that the US labour market is also seeing some progress, though data next Friday will reveal whether last month's improvements were a flash in the pan.

On the downside, US business investment is on the wane for the first time since Q1 2011. This really does suggest that concerns over the US fiscal cliff, which could do as much as halve US growth next year, are weighing on US confidence.

The UK economy grew by 1.0% in Q3, according to preliminary data released yesterday. This was considerably better than expected and triggered a much more noticeable reaction in the FX markets, with sterling making impressive gains as a result. The dollar has failed to capitalise on today’s data; it has had the effect of lifting market confidence and reducing demand for the safe-haven dollar. Nonetheless, the dollar has had a strong week regardless and we maintain a pretty rosy outlook for the greenback. The next big event, as far as the US is concerned, is the Presidential election result. The jury is out over whether a red or a blue victory would be best/worst for the greenback. 

Richard Driver

Currency Analyst

Caxton FX

Germany succumbing to peripheral eurozone weakness

Today’s session has seen some nasty eurozone growth data emerge, which has put the euro under even more selling pressure. Yesterday’s was a tough enough session for the single currency thanks to Moody’s credit downgrade to five Spanish regions; sterling/euro has helped itself to some very welcome gains again today.

Attention as far as the euro has been concerned has been focused on Spain’s “imminent” bailout request and Greece’s slow progress towards an agreement on further austerity measures that will unlock the next tranche of aid. Focus switched back to economic fundamentals today, which is not an environment in which the euro has thrived in recent months thanks to the regional downturn in economic growth. Brutal austerity measures throughout the eurozone periphery are not just hurting those struggling economies, the weakening demand is hitting the eurozone’s core, as shown by today’s German and French growth data.

September’s German manufacturing data suggested the weakness we have seen in the sector this year had bottomed out but October’s downturn casts a shadow over this theory. France’s manufacturing number came in below expectations, as did that of the German services sector.

A key gauge of the German business climate showed a sixth consecutive monthly decline, giving its worst showing since March 2010. What is interesting is that Ifo, the institute which produces the business climate survey, does not see any need for the European Central Bank to cut interest rates and does not see Germany heading into recession.

We are rather more bearish on the prospects of the European powerhouse. The composite measure of eurozone output has fallen to a 40-month low and points to an even sharper contraction in Q4 compared with Q3. Germany’s resilience to the eurozone region’s decline is a thing of the past and we are expecting a rate cut from the ECB in the coming months. The ECB might be doing its bit to ease concerns over eurozone contagion and a break-up, but growth in the region is crying out for help. 

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

MPC minutes suggest dovish majority in November

This morning’s MPC minutes release and UK employment figures brought some positive news for sterling, even if this didn’t translate in to any real demand for the currency today. The MPC minutes were not as dovish as they could have been, bearing in mind September’s update from the UK services, construction and manufacturing sectors were very disappointing. Meanwhile this morning’s UK unemployment figures beat expectations considerably, providing further optimism for a positive Q3 GDP figure on October 25.

The minutes revealed that there are clearly differing views within the MPC. Whilst no members voted for more QE in October, there are very likely to be members in favour of more QE in November. However, the MPC minutes and various speeches from members like Martin Weale and others such as Broadbent and Dale, reveal that there are plenty who doubt the need and indeed the actual usefulness of more QE.

Based on these minutes, it seems unlikely that the MPC doves will be able to form a majority in favour of QE in November. Martin Weale’s reservations over whether more QE is in line with the Bank’s inflation target could well convince some of the fence-sitters to hold fire on QE, as could the early indications that the Funding for Lending Scheme is stimulating credit conditions. Next week’s UK GDP figure could well have the final say for several voters.

Today’s UK employment figures have positive implications for the upcoming GDP figure. With the jobless rate dropping unexpectedly down to 7.9%, UK unemployment is at its lowest level since June 2011. The government will take a huge amount of comfort in the ongoing uptrend we are seeing in the UK labour market.

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: GBP, EUR, USD

Standard and Poor's cuts Spanish credit rating but Rajoy still delaying 

Rating agency Standard and Poor’s cut Spain’s credit rating by another two notches last week, which puts the country’s debt only one notch above ‘junk’ status. Moody’s already has Spain at this level but when it publishes its report in a fortnight, the market response could be very negative indeed if it does in fact downgrade Spain to junk territory. Speculation that Standard and Poor's axe wielding would prompt an aid request from Spain intensified last week but the latest reports suggest that not only will Rajoy wait until after regional elections on October 21 but he will wait until November before officially requesting a bailout. More delay then, though at least we have an idea of timescales.

Interestingly though, Spain’s bailout looks set to become part of a larger package containing a bailout for Cyprus and an amended loan package for Greece. This will relieve EU officials of the requirement to repeatedly obtain approval from the eurozone’s national parliaments. In terms of the eurozone’s other key problem child, a Greek deal on a new austerity package is likely to be agreed in time for this week’s EU Summit, which should help to set market nerves at rest with respect to the next tranche of Greek aid.

In terms of eurozone data this week ,we have a key German economic sentiment gauge released on Tuesday, which looks likely to improve slightly, though probably not enough to trigger any rally for the euro.

Big week of UK announcements ahead 

Last week brought a lull in terms of UK news. We learnt UK manufacturing production underperformed in August and that the UK trade deficit widened quite dramatically, but the week ahead brings plenty of key domestic figures. UK inflation is set to take another sharp downturn, which could well embolden the more dovish members of the MPC to vote for more QE next month. The minutes from the last MPC meeting are also released on Wednesday, which may be slightly more downbeat based on September’s weak PMI growth figures. This could potentially hurt the pound if it is enough to convince investors that a few members will be swayed to vote for more QE in November.

UK labour data looks set to be solid again on Wednesday, while we should also see some better growth from the UK retail sector. The market will watch all these figures closely but one eye will be kept on next week’s (October 25) initial Q3 UK GDP estimate. This is the next major event for sterling this month.

We are expecting plenty of range-bound trading this week, with EU leaders set to put off major announcements until next month. Having failed once again ahead of $1.61, GBP/USD looks set to return to the $1.60 level. We are sticking to our guns in terms of our predictions that when this pair does finally make a sustained break away from the $1.60 level, it will be to the downside. The euro continues to look tired as it approaches the $1.30 level and a dip below $1.29 looks possible this week.

Sterling is struggling to sustain any significant gains against the euro. We expect the €1.2350 will provide plenty of support in the sessions to come, so we’d view current levels to strong ones at which to sell the euro. A break higher back up towards €1.26 isn’t out of the question this month.

End of week forecast
GBP / EUR 1.2450
GBP / USD 1.5975
EUR / USD 1.2850
GBP / AUD 1.5800

Richard Driver
Currency Analyst
Caxton FX

What the fiscal cliff could mean for the US and global economy

With the US fiscal cliff less than three months away, the International Monetary Fund has chimed in this week with its concerns for both the US and the global economy as a whole. The US is edging towards an enormous fiscal tightening the like of which we haven’t seen since 1947. The nerves, pressure and speculation surrounding the issue will only going to intensify as US politicians argue and stall their way through the final quarter of the year.

The IMF has estimated that if a deal isn’t reached to avoid a full-blown fiscal cliff, then the US could well plunge into recession next year. The organisation estimates that the US economy will grow by 2.1% in 2013, while the impact of the fiscal cliff would weigh on GDP by 2.2%.

While the fiscal cliff does not appear to threaten a global recession next year, it would certainly have a significant impact; rating agency Fitch has estimated that it would cut global growth in half. As far as eurozone growth is concerned, developments from within the region could easily tip the IMF’s 2013 eurozone GDP forecast of 0.2% well and truly into recession territory regardless of the fiscal cliff. However, the organisation sees the failure to reach a compromise on the fiscal cliff knocking 0.4% off growth, which would seal the deal regardless.

If an agreement between the Republican controlled Congress and Democrat controlled Senate, it is highly unlikely that the payroll tax cut will be extended - there appears to be consensus on this issue. The expiration of this tax cut then will likely shave 1.0% off US GDP, which is nearly half the amount that the IMF is estimating of a full-blown fiscal cliff. This would leave global growth down around 2.6% in 2013, instead of the 3.6% the IMF is anticipating on the assumption a deal is reached. Unless US politicians pull a rabbit out of their collective hat, the fiscal cliff issue is likely to end in pain for all concerned, just how much pain is the real question.

Richard Driver

Currency Analyst

Caxton FX 

GBP/USD Outlook for Q4

US growth data pointed to a marked slowdown in Q3, which prompted the US Federal Reserve to finally deliver the long-awaited QE3 in mid-September. This has helped to keep the dollar on the back foot for much of the last month. The prospect of another round of QE to boost the world’s largest economy allowed US and European equities to maintain their summer momentum, never an environment conducive to dollar-strength.

The ECB’s pledge to purchase unlimited quantities of distressed debt (particularly Spain’s) and the Germany Constitutional Court’s approval of the European Stability Mechanism, which has been launched this week, also eased market worries and weakened demand for the safe-haven US dollar. This all coincided with a solid upturn in UK data; growth in August particularly picked up around the Olympics and GDP data for Q2 was revised up to an improved -0.4%.

However, some poor UK growth figures in the past week from the manufacturing and services sector in particular have taken the edge off the GBP/USD rate. Investors are once again stepping up their bets that the BoE will decide in favour of further QE in its closely watched November meeting. Much will depend on the initial UK GDP for Q3, which is released on October 25. The NIESR’s estimate this week of 0.8% growth may be a little too punchy.

Eurozone frustrations are now creeping into some dollar-strength. Spain is dragging its heels on requesting a bailout, while there remains uncertainty surrounding whether or not Greece will receive its next bailout tranche and whether we will see another Greek debt restructuring. In addition, we have seen plenty of evidence that not only is the eurozone heading into a recession, but that Germany could well be unable to resist this downward spiral. Some distinctly gloomy growth forecasts for the global economy from the IMF have also weighed heavily on market sentiment this week.

The combination of renewed weakness in UK data and renewed eurozone concerns saw the GBP/USD pair top out at $1.63 last month. This level represented a one-year high and GBP/USD’s resounding failure to breach this benchmark has resulted in a fairly sharp decline to $1.60, where it is currently finding support.

We expect the dollar to maintain the ascendancy in the fourth quarter, which should force the GBP/USD rate to make a sustained move below the $1.60 level in the short-term. Beyond this, we see the rate closer to $1.55 by the end of the year. There is plenty on the horizon to be nervous about; the US election and fiscal cliff, Spain (including probable credit rating cuts), Greece and global growth, which should all filter into a stronger US dollar. This baseline scenario of a lower GBP/USD rate relies on a decline in the EUR/USD rate and a continued loss of momentum in global equities, both of which we are sticking to. One major caveat to this positive outlook for the USD is that at some point in the coming weeks, Spain looks likely to bite the bullet and request help, which will likely give the euro a temporary lift and hurt the USD. 

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Market Round-Up: GBP, EUR, USD

US dollar finding its feet at last The US dollar has enjoyed itself in recent sessions, amid returning eurozone frustrations and a surprise drop in the US unemployment rate. Last Friday saw the US jobless rate drop to 7.8%, which is the lowest level seen since January 2009. The labour market report was by no means glowing but it did point to growth, which is a becoming a worryingly absent feature in many major economies. Labour market progress wasn’t the only source of optimism. This month’s US services sector figure was the best seen in six months, while the US manufacturing returned to positive growth territory for the first time in four months. Clearly the US economy faces major headwinds but the absence of further deterioration has helped the dollar to bounce back in the past three weeks or so. Concerns over the eurozone situation have also been a key factor behind the US dollar’s resurgence. PM Rajoy has resisted market pressure to request a bailout and in doing so has failed to reduce the uncertainty that surrounds the situation. On a more positive note, newswires are full of reports that Greece will receive its crucial next tranche of aid in November, though the market remains edgy on speculation of another Greek debt restructuring. Investors are unlikely to welcome more haircuts. The IMF has chimed in with some global growth forecasts this week and the picture does not look pretty. Assessments of Spanish and Italian GDP were bleak with estimates of 1.5% and 2.3% contractions this year. The IMF expects China to avoid a hard-landing, though the slowdown will still be significant, while growth in other BRIC nations provides plenty of reason for investors to be cautious. UK data disappoints but Q3 GDP should provide some optimism This month’s updates from the UK manufacturing, construction and services sector all disappointed, revealing a post-Olympics slump. This wasn’t enough to prompt the BoE into any further emergency easing measures in its October meeting, though bets have since increased on the prospects of more quantitative easing in November. We are still expecting a decent showing from the Q3 UK GDP figure at the end of the month. Indeed a leading think tank has today suggested a 0.8% result on the 25th October. Sterling is trading off its recent lows of €1.2350, which represents 81p in terms of EUR/GBP. Sterling is now trading over half a cent higher and we do see it heading higher within its range in the coming few sessions, provided we don’t see any major headlines of progress from the eurozone. Against the US dollar our outlook for sterling is rather less optimistic. GBP/USD has today lost grip of the $1.60 handle, dipping below this psychological level for the first time in a month. We expect the recent $1.63 high to represent a ceiling, but current levels are still strong as far as buying dollars are concerned. Our year-end forecasts for GBP/USD bring the rate much closer to $1.55. End of week forecast GBP / EUR 1.2450 GBP / USD 1.5900 EUR / USD 1.2770 GBP / AUD 1.5900 Richard Driver Currency Analyst Caxton FX

Sterling struggles as UK growth runs out of steam at end of Q3

After an excellent few weeks in which UK figures repeatedly beat expectations to the upside, this week’s figure reveal that UK growth slowed up in September, which represents a disappointing conclusion to the third quarter. All three of the monthly updates from the UK manufacturing, construction and services sectors came in softer than consensus expectations, which is likely to bring the UK government firmly back down to earth.

The Chief Economist of Markit, the company which compiles the PMI data that we are talking about, has suggested today that UK GDP will only grow by 0.1% in the third quarter, which is well below our and the market’s expectations. Before this week, we were roughly in line with consensus expectations of a GDP showing of 0.6%. Clearly this week’s figures cannot be ignored but a downward revision to 0.1% is a little too drastic for us. We are still anticipating growth close to the 0.5% mark. The August Inflation Report from the BoE, which anticipated growth of as much as 1.0% in Q3, is likely to be well wide of the mark.

Although today’s services data suggests that the steady and impressive improvements we have been seeing in the UK labour market may be coming to an end, the order books are at least looking pretty healthy. Still, the figures do firmly indicate that the strength in the UK economy seen in August was down to temporary Olympics-related demand. Underlying growth appears to be significantly weaker.

Many market players will naturally respond by speculating that the Bank of England will react with another round of QE. Thursday will not produce a QE decision, though November’s BoE meeting is likely garner far more debate from within the MPC. Much will depend on the Q3 preliminary GDP reading at the end of the month.

Richard Driver

Currency Analyst

Caxton FX

October Monthly Outlook: GBP/EUR and GBP/USD

Sterling to benefit from resurgent UK economy

From the eurozone, September’s two key events were ECB President Draghi’s announcement of his long-awaited bond-buying plan and the German Constitutional Court’s decision to approve the permanent bailout fund. Since then, there has been a real lack of any further concrete developments, which has understandably frustrated many market players and caused some risk aversion. As the next major event in the timeline of the eurozone debt crisis, speculation over the imminence of a Spanish bailout request is dominating market thinking at present. PM Rajoy does not actually appear to be much closer to making a formal request; he looks likely to wait until after Spanish regional elections to be held on October 21.

From the US, we have finally seen Ben Bernanke deliver what the market has been waiting for – more support for the US economy in the form of QE3. The move was priced in to a large extent but the dollar has been unable to stage any significant recovery in the immediate aftermath of the Fed’s announcement.

Conditions here in the UK continue to look a little brighter, though understandably many investors will still need further positive evidence to be truly convinced that the economy is on a path to a sustained recovery. However, with the Japanese and US central banks engaging in QE in September and the European Central Bank also taking monetary easing measures of its own (though rather more unconventional), the market is beginning to look more favourably upon the pound again.

GBP/EUR

Spanish delays will hurt the euro

Sterling has made a decent recovery against the euro in recent weeks, after what was quite a sharp decline as a result of the optimism that followed the announcement of the ECB’s bond-buying plan. There has been a positive response to some of the UK figures that have emerged in recent weeks; trade balance data revealed a dramatic rise in exports to destinations outside the EU, suggesting UK businesses are adapting to deteriorating eurozone demand. Meanwhile, UK unemployment figures continue to defy the overall weak picture of UK economic growth by making significant strides. From retail sales data to public sector borrowing figures, the UK economy has been beating market expectations time and again and this is filtering into some sterling strength. Another positive has emerged with the latest upward revision to the UK’s Q2 GDP figure to -0.4%, considerably better than the original estimate of -0.7%. Hopes are high for a very strong showing for the Q3 UK GDP figure released on October 26.

The minutes from the MPC’S September meeting revealed a unanimous vote against further QE (for now). The decision in favour of leaving the BoE 0.5% base rate unchanged was also unanimous. The fact that one MPC policymaker saw a good case for QE in September did not go unnoticed but as things stand, the Bank of England is understandably in wait-and-see mode. In light of the increased room for domestic optimism and the easing of financial conditions in the eurozone in recent weeks, it will not come as much of a surprise to learn that we are not expecting any fresh monetary easing measures from the Bank of England this month. November is likely to see the Bank assess its options much more carefully though.

Coinciding with strong economic figures has been an increased appetite for the pound as a relative safe-haven. Gilt yields have declined in recent sessions as investors attempt to take cover from renewed uncertainties from the eurozone and as usual this has boosted the pound by association. With the QE decisions from the US Federal Reserve and the Bank of Japan in September, sterling has climbed a little higher up many investors’ wish lists in recent weeks.

Putting improved UK conditions to one side, the major factor behind GBP/EUR’s climb in the past month has been a shift in sentiment against the euro, as is predominantly the case when this pair climbs. The market relief that followed the ECB’s commitment to buy unlimited quantities of distressed peripheral debt has well and truly worn off. Investors have refocused on the major issues facing Spain and Greece in particular.

PM Rajoy has thus far snubbed the opportunity to take advantage of the ECB’s offer to purchase Spanish debt, fully aware of the austerity demands that will accompany such intervention. Rajoy is under enormous pressure domestically, with the rich Catalonia region demanding independence and fierce protests taking place in Madrid over existing austerity measures. The market is likely to have to wait until after regional elections held on October 21 for Rajoy to bite the bullet, which leaves a good three weeks of frustration ahead. That said, if rating agency Moody’s cuts Spain’s credit rating to ‘junk’ status, then a spike in Spanish bond yields could force Rajoy’s hand a little sooner.

Greek saga remains volatile

The situation in Greece also remains typically uncertain. October is an important month too, with some chunky bond repayments maturing. Disagreements not only exist between Greece and the Troika (EU, ECB and IMF) but between the IMF and the EU. With the Greek debt profile blown even further off track by a deeper than expected recession, the IMF is now pushing for another Greek debt restructuring in order to get its debt sustainability back on track. Unsurprisingly, more ‘haircuts’ is not at the top of the EU’s list of priorities.

It looks as if there is some consensus over giving Greece an additional two years to meet its targets and the government appears to have been reached an agreement for €13.5bn in additional spending cuts that they hope will unlock the vital next tranche of aid. However, the agreement still needs Troika approval and would need to be approved by the Greek parliament, which amid violent public protests in Athens is no dead cert. Speculation has surrounded the need for a third Greek bailout but this option looks to be a non-starter as it would require parliamentary approval from individual member states. The bottom line is that Greece may well leave the eurozone but EU leaders are unlikely to let this happen while conditions in Spain remain so tense. The pressure for stronger signs of progress will be turned up once again at the next EU Summit on October 18-19.

Sterling has recouped its mid-September losses against the euro and is back trading above the €1.25 level. With market confidence so shaky at present, any concrete progress - most importantly from Spain in the form of a bailout request – will likely give the euro a significant lift. However, our baseline scenario is that this will not occur and that sentiment will continue to weaken towards the euro, helping sterling to build on its domestic economic resurgence and resume its uptrend against the euro.

GBP/USD

Dollar to strengthen despite QE3

The US Federal Reserve finally pulled the trigger on QE3 in September, which meant it was another very soft month for the US dollar. There have been some bright spots amongst US figures in the past month, with trade balance, retail sales and consumer confidence figures all showing some improvements. However, there has been plenty of evidence of continued economic weakness to support Ben Bernanke’s decision to turn the printing presses back on; last month’s key employment update gave little to cheer about. In addition, the final US GDP figure for Q2 was sharply and unexpectedly revised down to 1.3% from 1.7%.

The issues of weak US economic growth and a long period of quantitative easing are by no means at the top of most investors’ list of concerns. The US dollar has strengthened a little in the past fortnight, amid waning euphoria surrounding the QE3 announcement and the ECB’s pledge to purchase peripheral debt. Spain has not asked for a bailout, Greece has not secured its next tranche of aid and growth across the world is slowing. These are all dollar-friendly factors and the slowdowns being seen in China and the eurozone (including Germany) are of particular concern.

Whilst UK growth data has been remarkably positive in recent weeks, the ongoing fragility of the UK recovery has already been highlighted this week by a weaker than expected manufacturing figure. If sterling is to avoid another short-term sell-off against the US dollar, the UK services figure released on October 3 must be firm. However, sterling should get plenty of support in the form of the preliminary Q3 UK GDP figure released on October 26; we are looking for a robust quarterly showing of around +0.6%.

As things stand, sterling is trading almost two cents below September’s 13-month high of $1.63 and we think this high will remain a ceiling for this pair. Regardless of QE3, we see plenty of scope for increased demand for the safe-haven US dollar. We are still anticipating weakness in the EUR/USD pair, which should send GBP/USD back below $1.60 in October. 

Richard Driver

Currency Analyst

Caxton FX