Caxton FX Currency Blog

Sterling finally breaks through the 1.70 resistance against the US dollar and maintains its position

GBP – The start of the week saw sterling maintain its strong position as BoE Deputy Governor Bean highlighted that there is optimism surrounding the current state of economic recovery and that there was a better balance in the UK financial system. He also stated that if and when we do see policy tightened, it will be a clear indication that the economy is back on track to being normalized again. On the data front, the consumer price index, which is a key gauge of inflation, slipped to a four and a half year low after the first year-on-year fall in food prices since 2006. With the UK economy growing at such a fast pace, low inflation has allowed the BoE to keep interest rates at a historically low 0.5%. The BoE did mention in their policy meeting minutes that inflation was not a concern due to the fact that sterling appreciation putting downward pressure on prices was the main reason behind the decline we have seen since April. With the outlook for the UK economy remaining positive, it is not surprising that the BoE policy meeting minutes showed that the policy decision remains balanced. With the central bank reiterating that they would act cautiously and that any hike in rates would be gradual, it appears even more likely that we could see some policy tightening before the end of the year. On the back of the positive sentiment out of policy meeting minutes, sterling finally broke the 1.70 resistance level against the US dollar and carried on to reach a new 5-year high. This week sees the release of UK GDP and current account figures. With growth in the UK on track to be the fastest-growing among the Group of Seven nations this year, we should see further sterling appreciation and it will be then down to the BoE to act accordingly. It will be important for policy makers to ensure that the currency doesn’t pull too far away from its peers but also allow the economy to start supporting itself again.

USD – The US dollar started the week rather tentative as market participants tried to evaluate the outcome of the FOMC meeting which took place on Wednesday.  There were further signs of economic recovery picking up as the nation’s industrial output increased for the third time in four months as US factories boosted production. The US consumer price index also increased by a stronger than expected 0.4% in May, above the forecasted level of 0.2%. The year-on-year rate of growth increased to 2.0%, which was which is the highest rate we have seen since early 2013. Despite the economic backdrop showing signs of improvement, there remains a significant amount of slack in the economy and consequently the Federal Reserve continued maintaining a dovish outlook following the FOMC meeting last week and hinted that interest rates are likely to remain historically low beyond tapering for some time. The Federal Reserve also revised the growth, unemployment and inflation forecasts for the year on the back of recent economic releases. This week sees the release of GDP data out of the US along with consumer confidence figures and durable goods orders. Many recent indicators have suggested that a rebound in consumer confidence and spending as well as production is already under way, putting the economy on track for improved growth on Q1. If we see signs of improvement, there is likely to be some upward pressure on the US dollar, as some hawkish sentiment returns to US dollar markets.

EUR – There was more downward pressure exerted on the euro at the start of the week as Eurostat showed that the headline inflation rate had plunged to 0.5% in May,  both on an annual and seasonally adjusted basis. Inflation in the region is currently at its lowest level since November 2009 and further justifies the ECB’s decision to take action as early as June.  With inflation indicators remaining significantly below the 2% target level for some time and the 1% level since November 2013, it will be more difficult for customers, governments and companies to reduce their debt levels. The German ZEW Economic Sentiment survey continued to decline and fell short of the estimate whilst the same survey for the region as a whole also fell below the forecasted level. It was expected that we would see a drop in confidence following the uncertainty surrounding the effect that negative deposit rates and a cut in the main refinancing rate will have on the economy. If inflation indicators in the eurozone don’t show signs of substantial improvement, the ECB will be under pressure to take stronger monetary measure at its July meeting and this could result in the euro falling to an unsustainable level. This week sees the release of important PMI services and manufacturing data out of the eurozone. With data currently having very little impact on the single currency, we expect the quote currencies to dominate any activity we may see in euro markets with uncertainty still playing on the minds of investors due to the vulnerability of the economic situation across the region.

AUD – The RBA stated at the start of last week that its current accommodative policy appears to be appropriate for some time and that low borrowing costs have helped support demand. It is expected that Australian GDP will grow below the normal level next year, as the economy gets to grips with fiscal consolidation and a decline in foreign investment, while inflation is expected to remain within the targeted levels. The central bank have said that it is difficult to gauge how much borrowing costs can offset a drop in investments of the mining sector and government spending cuts, especially with the Australian dollar remaining at historically high levels and not providing the assistance needed to rebalance growth. With Iron ore prices having fallen by 34% this year and the Australian dollar index, the nation’s main commodity index, by 9.5%, is appears as though there is still plenty of downside risk remaining, especially with Chinese growth expected to fall short of its target level this year. Amid the lack of any key data this week out of Australia, we expect the situation in Iraq to have a big say on any activity we are likely to see. With the Australian dollar looking more and more like a safe haven currency but the violence in Iraq putting pressure on commodity linked currencies, it will be interesting to see the positions which market participants take up with uncertainty building.

End of Week Forecast:

GBP/EUR – 1.2540

GBP/USD – 1.7050

EUR/USD – 1.3640

GBP/AUD –  1.8120

Kamil Amin
FX Analyst
Caxton FX