Caxton FX Weekly Report: A week in the back seat

A week in the back seat

The pound has come under pressure so far this week, and the struggle for sterling to maintain levels above 1.20 has resurfaced, at least in the short term. A quiet week on the UK data front leaves the pound vulnerable against the euro and dollar, although retail sales figures due on Friday may provide the market with a reason to put their money back into the pound. With UK inflation now on target, the Bank of England have even more room to maintain accommodative monetary policy, dampening expectations of a rate increase any time soon. Economic indicators continue to suggest that recent growth can be sustained and this should act as a cushion limiting potential losses. The threat of levels below 1.20 remain, especially if Eurozone inflation figures provide upside surprise, although the pound is looking well supported this week. Sterling has been softer against the dollar which has managed to recover after last week’s employment report. With levels now above 1.64, there is still plenty of room on the downside and we expect sterling to remain on the back foot, with some potential gains later on in the week.

A firmer euro but for how long

Although the euro remains in decent shape, we doubt the single currency has enough support in order to prevent higher levels going forward. With market participants closely watching inflation figures from both the UK and the Eurozone, we are likely to see a fair bit of volatility in this pairing. Any upside surprise from the Eurozone reading could easily spark some more downward movement in the GBPEUR rate.

The euro has had a more difficult time against the greenback, and despite the non-farm payrolls figure coming in significantly below estimates, the dollar seems to be dictating play this week. The stronger dollar has prevented levels of 1.37, whilst the single currency has shown its resilience, keeping levels above 1.36. The inflation figure will be the key driver for the euro this week and it is likely we will see some volatility on the back of this release.

The dollar shakes off the non-farm payroll releases
The greenback failed to start the week in the best condition as the US non-farm payrolls encouraged investors to sell the dollar and drive GBP/USD to 1.65. Those gains were quickly reversed, and the market has put last week’s news to the side with full focus on the jam packed week for US data. Retail sales have got the ball rolling and with these figures beating estimates, the greenback gained a little ground. The Beige Book, Philly Fed Manufacturing Index, and Preliminary UoM Consumer Sentiment will all be released this week. Dovish Fed members have raised concern about issue of low inflation, and so US inflation numbers due on Thursday will also be a focal point.

With little to support both the euro and sterling, the dollar seems to be in the
better position to gain. The market has ample opportunity to move on the back of
solid US figures, but any reading which disappoints will leave the window open for
the euro and sterling to take advantage.

End of week forecast

GBP / EUR	1.2100
GBP / USD	1.6350
EUR / USD	1.3600
GBP / AUD	1.8500

Sasha Nugent

Currency Analyst

Caxton FX

The Outlook for Sterling in 2014

The pound has started the year on a high, UK economic activity surprisingly picked up allowing growth to accelerate, ultimately improving sentiment. In particular, the labour market improved as the number unemployed decreased, alongside those claiming job related benefits. Concern about above target inflation faded as price pressures eased towards the Bank of England target of 2% y/y. Caxton FX is anticipating the GBP/EUR to continue on its upward trend to finish the year around the €1.26 level. Despite the surprising strength of the pound, we expect the dollar will rebound and drive the rate towards $1.53 by the end of the year.

GBP/EUR
The euro continues to be reasonably strong against the pound and the battle for sterling to sustain gains against the single currency continues. Despite the increased positivity about the UK economic environment, the pound is still struggling to really drive the rate clear of the 1.20 mark. Above target inflation is no longer a concern, and this has dampened expectations of a rate increase from the Bank of England limiting further gains for the pound. On this basis, we do not expect the central bank to raise rates this year, however we do expect the UK recovery to continue, potentially building the case for a tightening of policy early next year.

The issue of deflation may become a hot topic, especially during a time when many nations are suffering from deflationary pressures. Although UK inflation is on target for the first time in over 4 years, this could easily turn into a situation of disinflation. The market will definitely be keeping an eye on this as the year unfolds.

In the eurozone, inflation is definitely a hot topic, and although the ECB are confident that price pressures are well anchored to their medium to long term expectations, the concern remains. Nevertheless the eurozone is making progress and we expect this to continue. The outcome of the stress tests and asset quality reviews of European banks will also be extremely interesting, not to mention the effect these results will have on sentiment.

The outlook for the UK outperforms that of the eurozone and therefore we expect the pound to edge the GBP/EUR rate higher this year.

GBP/USD

The pound is hanging on to levels above 1.60, but we doubt this can be sustained in the months ahead. Despite the announcement of tapering failing to have any significant effect on the exchange rate, going forward we may see the effects of this begin to show. A mere $10bn reduction in asset purchases is hardly anything significant, but as the US economy picks up, the labour market improves, and inflation rises, we should see the Fed begin to reduce purchases by a more considerable amount supporting the dollar.

Optimism about the UK recovery may limit dollar gains, especially in the second half of the year when talk about a rate increase in 2015 is likely to resurface. How inflation develops in this period will also be important, but with both nations enjoying solid growth, attention will be on which central bank looks closer to tightening monetary policy sooner. The Federal Reserve has reiterated the fact that the wind down of purchases is not a tightening of monetary policy, and with the Bank of England looking just as committed to keeping rates low, we doubt we will see any tightening of policy from either central bank this year.

With worries about the US government debt ceiling diminishing, the tapering topic should keep the dollar on the front foot, and with the BoE also raising a little concern regarding the strength of the pound, we expect sterling to weaken in the months ahead.