The end of 2012 was characterised by euro strength and
dollar weakness, with sterling’s performance falling somewhere in between. We
have seen GBP/USD rally to fresh highs lately, while GBP/EUR has posted new
multi-month lows. Whilst our central scenario is that we will see these two
trends reversed over the course of 2013, we note significant short-term risks
to sterling vis-à-vis the euro. A weak UK GDP figure for Q4 2012 or a loss
of the UK’s AAA credit rating are likely to keep GBP/EUR below €1.25 in the
coming weeks, which is significantly below where we see it trading by this time
next year.
GBP/EUR
Sterling suffering
from UK triple-dip fears
December’s growth data pointed to a disappointing slowdown
in November, with the UK’s key services sector only narrowly avoiding a monthly
contraction. We have been warned in no uncertain terms by the Bank of England
that the UK economy could well have contracted in Q4 2012. The available
figures do indeed point to this, even if it is likely to be only marginal. Still,
talk of a triple-dip recession is hardly going to foster a mood of confidence
towards the UK recovery.
Looking ahead, the near-term outlook for UK growth is likely
to be flat, as the economy wrestles with ongoing weakness in demand from the
eurozone. We are simply not seeing the rise in UK exports that is necessary and
with the eurozone poised to continue contracting throughout the first half of
this year, this problem is unlikely to be addressed.
Chancellor George Osborne’s Autumn Statement, delivered in
December, told us that the UK government is sticking to its guns on fiscal
consolidation, which is likely to continue constraining growth, though we agree
that this approach is essential. However, weak growth in combination with Osborne’s
failure to make progress on bringing down the country’s soaring debt levels are
likely to convince at least one of the major credit rating agencies to downgrade
the UK’s triple-A rating. This is a risk for sterling, though we are among
those who are sceptical about just how much this would hurt the pound.
In terms of BoE monetary policy, we still only have one MPC
member (David Miles) voting in favour of more quantitative easing. The vast
majority of the voters appear content to allow the effects of the Funding for
Lending scheme to continue feeding through and unless we see evidence of
further significant economic weakness, we don’t expect any more QE until at
least the second half of 2013. As such, this month’s BoE meeting should yield
no major developments, though the release of the MPC minutes on Jan 23 will be
as closely watched as ever.
Euro strong but
fundamentals point to a decline
As far as the euro is concerned, we have to admit that we
are surprised to report GBP/EUR’s recent decline to an eight-month low below
€1.2150. Supporting the euro is the fact that Greece is out of the woods for
the time being and eurozone tensions have eased accordingly. The key driver of
the euro’s resilience, as ever, is the perpetual diversification of USD into EUR
by Middle and Far Eastern central banks.
Nonetheless, we continue to foresee a euro decline through
2013, led by declining economic fundamentals and ongoing eurozone risks. It
goes without saying that a weaker euro would benefit the eurozone economy.
However, using rhetoric to this effect was a rather dicey move for EU officials
last year, amid concerns over the very existence of the euro. We should see
greater opportunity for policymakers to take advantage of calmer markets and
talk up the merits of a weaker euro this year, without highlighting any
existential crisis on the part of the single currency.
In terms of what to look out for this year, elections in
Germany and Italy stand out as risk events, as does the likelihood of a Spanish
sovereign bailout request sooner rather than later. Fortunately for the euro, Germany
doesn’t go to the polls for another nine months, while Greece will likely stay
out of the headlines for time being. Longer-term, we do expect the eurozone’s
problem child to continue missing its targets, whilst there is also a risk of a
breakdown of the Greek coalition.
Political uncertainty in Italy poses one of the most
significant risks to the euro in the short-term; elections are likely to be
held in March. This should put Spanish bond yields under pressure, as would a Moody’s
downgrade of Spanish debt to junk status, which is looking probable based on
comments made by the rating agency last October.
Sterling has bounced off its multi-month lows in the €1.2150
region and is currently trading around €1.2350. We expect this pair to remain
fairly stable around this level in January, before edging back up towards €1.25
in the coming months.
GBP/USD
US steps away from
the fiscal cliff
2013 has kicked off with a bang thanks to the rather predictable
eleventh hour deal to avoid the US fiscal cliff. The absence of such a deal
would have seen highly damaging tax rises and spending cuts coming into the
force on January 1. The US Congress has taken a leaf out of the eurozone’s book
by effectively kicking the can down the road but fiscal tightening will
nevertheless be a major feature of the US economy this year. The Congressional
Budget Office is expecting the US economy to grow by around 2.0% in 2013, which
factors in a 1.4% reduction due to spending cuts.
The fact is that nothing of any real substance has yet been
decided on American fiscal reform. The next two months will be the subject of further
fierce negotiations on what cuts are made and where. The dysfunction of the US political
system over recent years almost guarantees a further headline grabbing crisis
in the coming months. Indeed, Moody’s and Standard & Poor’s have ramped up
the pressure by branding this week’s deal “insufficient.”
Where does this all leave the GBP/USD pair? Well, the dollar
has performed remarkably poorly in recent weeks and sterling actually mustered
the strength to rally to an impressive fifteen-month high of $1.6380 in early
New Year trading. However, the dollar is showing some initial signs of a
rebound with this pair having retreated by over two cents from the aforementioned
high.
Buying USD above
$1.60 remains attractive
Put simply, we have seen any level above $1.60 as a strong
opportunity to buy USD for a while now, so current levels of $1.6150 still look
highly attractive. We have to admit that this pair finished 2012 significantly
higher than we expected, but we remain confident that the greenback will find
its feet in 2013. Behind this is a belief that economic fundamentals will
acquire a greater share of market focus this year. With the US economy easily
outpacing its US and UK counterparts, even after the effects of fiscal
consolidation are factored in; increased focus on economic performance should
benefit the greenback. In the short-term though, January should provide some
more shelf-life for this pair above $1.60.
One month direction:
GBP/EUR: €1.2375
GBP/USD: $1.61
EUR/USD: $1.30
Richard Driver
Currency Analyst
