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

September Monthly Outlook: GBP/EUR, GBP/USD

August was another strong month for the single currency as the financial markets continued to take comfort in ECB President Draghi’s pledges to do “whatever it takes” to save the euro. There were no major swings among the major pairings, with August typically being a sleepy month where traders and policymakers alike take their summer vacations. Despite a recent upturn in US economic figures, the dollar remains on the back foot, with QE3 speculation more prevalent than ever.

Recent domestic data suggests conditions have improved somewhat in the past month, which gives hope to the market and consumers that the UK economy can yet stage some sort of recovery in the second half of the year. The Bank of England will be content to see how this bounce in activity progresses, so fears of imminent quantitative easing should subside for the time being. Moreover, with a busy calendar for the US and the eurozone in the coming weeks, the UK economy is very much out of the spotlight at present.

The month ahead could well be a pivotal one in the timeline of the eurozone debt crisis. We are seeing the European Central Bank preparing to launch a programme of unlimited bond-purchases as part of a wider bailout package for Spain. The pressure will now build on Spanish PM Rajoy to make the necessary request for help but the conditions Germany pushes for is likely to be subject to tense negotiations.

Next week (September 12) brings the long-awaited decision from the German Constitutional Court on the legality of the European Stability Mechanism and the fiscal compact agreed earlier in the year, around which there is considerably uncertainty. There is also plenty of political risk in the form of a general election in the Netherlands, while the Troika will spend much of September assessing Greece’s attempts to reform before deciding on whether to release the essential next aid tranche. In addition to all these eurozone events, we will learn whether the Fed will finally pull the trigger on QE3 this month.

GBP/EUR

Sterling remains at strong levels against the euro; it is quite clear that the market has spent recent weeks waiting to see how September’s events panned out before punishing the euro any further. Indeed, whilst decisions and concrete actions have yet again been conspicuous by their absence, comments from ECB policymakers and eurozone political leaders have been falling on sympathetic, or rather, hopeful ears. This has fuelled a rebound for the euro.

Signs of life in the UK economy

The UK economy has enjoyed some good news in the past week in the form of some better than expected manufacturing and services sector growth figures, with the latter in particular raising hopes for a recovery. UK unemployment continues to make progress, with the jobless rate falling to an 11-month low of 8.0%. However, the market will need more convincing that the worst of this double-dip recession is behind us before sterling really begins to reap the benefits of improved data. The initial Q2 GDP figure of -0.7% was revised up to -0.5% but confidence is understandably still very fragile. The Bank of England looks content to remain in ‘wait and see’ mode with respect to the need for further QE, so the risks to sterling in this regard are limited for at least the next month.

Will Super Mario save the day?

Positivity surrounding an imminent bond-purchasing plan to deal with soaring Spanish and Italian borrowing costs has been the key feature of the debt crisis in the past few weeks. Timescales as to the launch are immensely tricky to pin down due to the need for Spain to request help from the ECB but the central bank’s fire-fighting measures are likely to be seen a positive for the euro when it does finally come about.

However, these unconventional measures do little to address the fundamental issue at the heart of Spain and Italy’s predicament – their lack of competitiveness. The eurozone periphery cannot bounce back with the euro as overvalued as it continues to be (regardless of the depreciation we have seen this year). Indeed the ECB’s commitment to fire-fighting this summer has exacerbated the situation by strengthening the euro. Crisis management policies like bond-purchases will not see the eurozone through this crisis. We have seen this year that ECB interest rate cuts weaken the euro and for us, it is only a matter of time before the ECB takes this option again, finally putting concerns over inflation to one side. The incentive to cut rates is all too clear; the ECB itself has this week significantly downgraded the eurozone’s growth prospects for both this year and next (possibly as low as -0.6% and -0.4% in 2012 and 2013 respectively).

The ECB and Germany’s opposition to granting the ESM a banking license also continues to stand in the way of any so-called ‘silver-bullet’ solution. Such a move would effectively give the permanent bailout fund unlimited access to ECB funding, eliminating the concerns that linger over inadequate firepower.

Huge risk events ahead in September

The next major obstacle in store is the German Constitution Court’s ruling on whether the new role for the ESM (the permanent bailout fund) and the eurozone’s fiscal compact complies with German law. If it does not, then this would be disastrous for the euro and while the probability is of a positive outcome, the risks to the contrary are significant. September 12 is made all the more important by the Netherlands’’ general election, which has been centred on the issue of the debt crisis. If anti-austerity parties do as well as polls are suggesting, then this is likely to weigh on the single currency.

Concerns over Greece are likely to come to the fore again this month, as the Greek coalition struggles to work through another €11.5bn of spending cuts and as the Troika returns to complete its review of Greece’s efforts to address its fiscal position. A positive Troika report is necessary in October if Greece is to receive its essential next emergency loan, without which it will default and most likely exit the eurozone.

Sterling may well have another slow month against the euro in September as the market prices in a (temporary) resolution to Spain’s crisis. However, we do see this pair resuming its uptrend beyond the short-term, slowly creeping higher towards, though probably falling short of €1.30 by the end of the year. €1.25 should provide plenty of support and we don’t see sterling weakening below this level but equally, provided the German constitutional court give a positive ruling on the ESM and fiscal compact, sterling could well spend much of the coming weeks below €1.2650. 

GBP/USD

Sterling is flying at a 3 ½ month high at present, despite the UK economy’s significant underperformance of its US counterpart. The QE3 issue continues to haunt the US dollar and delay what we continue to believe will be a robust end to the year for the greenback. There is no doubt that the US Federal Reserve has engaged in greater discussion of further monetary accommodation, with several policymakers convinced of the need of QE3. However, Ben Bernanke chose not to utilise his annual Jackson Hole speech to signal another round of QE, though crucially he said nothing to discount it.

Can the US dollar avoid QE3?

It does appear to be a case of ‘when’ not ‘if’ with regard to QE3. The Fed’s reasoning on QE3 seems to have changed from a stance of committing to more QE in the event that the US recovery deteriorates further, to a commitment to QE unless conditions markedly improve. Economic figures out of the US have been somewhat improved in the past few weeks, which may well convince Ben Bernanke to keep his powder dry on September 13. However, there is every chance that Q4 will bring the decision the market is hoping for.

The sounds out of the Bank of England in recent weeks have given the market some reason to look kindly upon the pound. A cut to the BoE’s already record-low interest rate has effectively been discounted and Mervyn King appears content to wait to see the impact of its Funding for Lending Scheme before introducing further quantitative easing. Whether or not more QE comes in November really depends on growth figures in the interim but the latest indicators do suggest a mild upturn.

Nonetheless, we continue to envisage a significant move lower for the EUR/USD pair in the coming months. If this comes about, it will weigh on the GBP/USD pair to a great extent. The euro’s rally against the USD is looking increasingly stretched at current levels of $1.2650 and given that we see this pair below $1.20 by the end of the year, we do expect GBP/USD to retreat significantly from the $1.59 level where it is trading at present. A rate of $1.57 is realistic in the coming few weeks. 

Richard Driver 

Currency Analyst 

Caxton FX

Will Bernanke signal QE3 at Jackson Hole on Friday?

The US Federal Reserve’s annual retreat to Jackson Hole, Wyoming is always a headline-hitter. In 2010, Fed Chairman Ben Bernanke signalled QE2 in his Jackson Hole address and hopes are sky high that he will usher in a third round of quantitative easing tomorrow afternoon. Coupled with the eurozone debt crisis, US monetary policy has been the market’s obsession for a long time now.

The US recovery certainly hasn’t bounced back as expected from the weakness prevalent in the first half of the year. However, US data has been on an uptrend of late. We have seen monthly jobs growth improve for three consecutive months, whilst housing figures and consumer sentiment have also been on the up. In addition, data this week has revealed that the US economy grew at an annualised rate of 1.7% in Q2, rather than the initial estimate of 1.5%. This won’t have gone unnoticed at the Fed.

The minutes from the Fed’s last meeting stoked QE3 earlier bets this month, hinting that Bernanke & Co were preparing to act - “many members judged that additional monetary easing would likely be warranted fairly soon.” However, the wind was soon knocked out of the market’s sails when Fed policymaker Bullard stated that the minutes were “stale,” pointing to the upturn in recent US growth data as good reason for investors not to get ahead of themselves.

Nonetheless, it is probably fair to say that the majority of market participants are expecting Bernanke to signal QE3 tomorrow. It’s without doubt an extremely close call but our bet is that he will fall short of this benchmark, particularly in light of recent data. The Fed has various other policy options at its disposal, such as giving guidance on how long he expects US interest rates to remain “exceptionally low.” The bar has been set high though, only a QE3 signal is like to satisfy the market’s appetite tomorrow.

What will be the market’s response to the absence of a QE3 hint? Well, equities will no doubt take a hit and commodities and precious metals would follow suit. As for the dollar, well it should rally if Bernanke disappoints. Even if Bernanke gives the market what it wants, with QE3 priced in to the extent that it is, there is a good chance that investors will choose to take profit on short-dollar positions, which again would strengthen the greenback. With this in mind, we would prefer to be long of the dollar ahead of Jackson Hole. 

Richard Driver

Currency Analyst

Caxton FX

Sterling set for a tough month

As has been the case for many months, eurozone concerns dominated market sentiment in July, so much so that the euro hit fresh multi-month lows across the exchange rates. Immediate concerns over the situation in Spain and Greece hurt confidence significantly, with weak economic growth across the globe adding to concerns. However, market sentiment and the euro have picked up considerably in recent sessions.

After the so-called progress that was made at the June EU Summit, there have been no material developments. The peripheral bond markets are always a good indicator of market tensions with regard to the debt crisis and Spanish 10-year bonds have hit fresh euro-era highs above 7.6% in recent weeks, with equivalent Italian debt setting its own record above the 6.5% level. Whilst economic growth throughout the eurozone is contracting sharply, Spain is edging towards a full-blown bailout and Greece could yet fail to secure its next bailout tranche, which is essential if the country is to avoid collapse.

Economic conditions in the US continue to provide plenty of cause for concern. The US economy slowed from a pace of 2.8% in Q4 2011 to a pace of 1.5% in Q2 2012. Poor performance in the world’s largest economy stunted the US dollar’s progress in recent weeks by increasing speculation that the US Federal Reserve is edging towards introducing the much-debated QE3 measure. However, the Fed’s recent meeting produced yet more ‘wait-and-see’ rhetoric, which has taken some weight off the dollar for the time being.

News out of the UK has also been far from comforting. Recent data has indicated that the domestic economy contracted by 0.7%, which is a shockingly poor figure well below expectations. The Bank of England has introduced another round (£50bn worth) of quantitative easing and the government has initiated an interesting new Funding for Lending Scheme to encourage banks to step up lending, but the effects of these are some way from being felt. In the meantime, UK growth is expected to remain very weak indeed. Sterling still holds some safe-haven demand, though this may be insufficient for it to avoid losses against the euro and dollar this month.

GBP/EUR

Having hit near four-year highs up towards €1.29, this pair has since erased its gains and at the current level of €1.26, it is back where it started in July. Whilst we do maintain that the pound will remain on its longer term uptrend, we anticipate some further short-term sterling softness in the coming weeks.

Spain spooked the markets in July, with borrowing costs soaring well above the 7.0% level amid a request from the Spanish regional government of Valencia’s request for financial aid and concerns of similar emergency needs across Spain’s regions. Spain’s banks have already agreed a bailout with international creditors and it has certainly discussed a full-blown sovereign bailout with Germany, which continues to demonstrate growing bailout-fatigue. In terms of austerity and economic reforms, PM Rajoy is doing all he can but investors are still hammering Spain in the bond markets. A sovereign bailout is looking increasingly unavoidable.

Last week’s ECB meeting was the most eagerly-awaited in a very long time but the market was left wondering what could have been. Draghi had a plethora of options available to him and after he stated that he would do “whatever it takes” to preserve the euro, he delayed any action whatsoever. The decision not to cut interest rates was unanimous after June’s 0.25% reduction, despite ECB President Draghi predicting that the eurozone economy is likely to recover only very gradually, whilst noting significant risks to further deterioration. Q2 was an awful one for the eurozone, with weakness in the periphery spreading to core states including Germany. The latest German and French manufacturing figures reveal a sharp contraction and eurozone unemployment remains a major issue, having recently reached a fresh record high of 11.2%.

Draghi disappointed the markets by suggesting that the European Stability Mechanism will not be granted a banking license, which had been previously indicated by an ECB policymaker and would have greatly increased the bailout funds’ firepower. Importantly, Draghi indicated that the ECB may move to buy up peripheral debt to ease pressure in the bond markets, but his comments fell short of a pre-commitment, never mind concrete action. German resistance to ECB bond-buying and demands for fiscal restraints represent a key obstacle to ECB emergency action.

Whilst alarm bells ring in the eurozone, the UK economy is also in a very weak state, which is best demonstrated by the recent-0.7% GDP figure from Q2, leaving the UK economy firmly in recession. Initial signs have not been positive for Q3 either; the UK manufacturing sector posted its worst figure in three years and the UK services sector gave its worst showing in eighteen months in July.

The Bank of England is clearly concerned with economic conditions in the UK, having introduced another round of quantitative easing in July to support the economy. The MPC voted 7-2 in favour of the £50bn top-up and there were suspicions that another dose would be approved at its recent August meeting in response to the latest shock GDP figure, though sterling has been spared this development. The government has also taken its own action to try to drag the UK out of recession in the form of its Funding for Lending initiative, designed to incentivise UK banks to increase lending, something that the Project Merlin initiative failed to do.

It needn’t be all pessimism towards the UK economy; there remains some fairly strong scepticism over the reliability of the awful initial Q2 UK GDP figure and in combination with the improved weather conditions, hopes for a significantly stronger second half of the year are not misplaced. The effects of the additional round of QE, the Funding for Lending programme should help the UK return to growth, though this may have to wait until Q4. Unfortunately though, initial expectations that the London Olympics will add 0.5% to UK GDP this year are receding.

The sharper than expected recession has highlighted the question marks over the UK’s treasured AAA credit rating. Rating agency Moody’s has retained its negative outlook for the UK’s credit rating, though fears have been quelled somewhat by Standard & Poor’s recent reaffirmation of the UK’s top rating with a stable outlook.

Sterling is trading at €1.26 at present, which represents a pretty aggressive decline from its multi-year high of €1.2878. With weak UK growth figures set to flow this month, we expect this rate to retrace further in the coming weeks down to €1.25. There is a risk that this pair will revisit its June lows of €1.2270 but on balance we think this is unlikely.

GBP/USD

Sterling has remained range-bound against the US dollar over the past month, fluctuating between $1.54 and $1.57. The news out of the US economy has broadly been very disappointing; June’s labour figures were alarmingly poor, manufacturing data was shaky and retail sales contracted sharply. In addition, the US economic growth rate of 1.9% (annualised) in Q1 slowed down to 1.5% in Q2 - almost half of the rate we were seeing at the end of last year.

Naturally, weak growth figures saw bets on QE3 ramped up yet again, which has been a thorn in the US dollar’s side for some time now. Ben Bernanke disappointed the market yet again in his July US Federal Reserve Press Conference. There was no QE3 announcement, nor any real signals that a move is imminent. Clearly this is good news for the US dollar, if not for global market confidence.

The recent release of July’s US non-farm payrolls figure should free up the US dollar to make some gains this month. Data revealed that 163 thousand jobs were added to the payrolls in July, which represents the best showing in five months and should ease fears of a sharp slowdown in the US for now. One thing is certain though, QE3 will remain very much on the Fed’s list of options for the foreseeable future. We see the Fed pulling the trigger on QE3 at some point in Q4.

Despite Moody’s recent reaffirmation of the UK’s AAA credit rating, market confidence in the pound appears to be waning thanks to a steady flow of weak UK growth figures. More of the same can be expected this month and to make matters worse, anecdotal evidence suggests the Olympics will fail to provide the economic boost that was initially expected. The Bank of England held off from adding another dose of QE at its July meeting but suspicions of another top-up will grow with every negative piece of UK data.

We hold a negative view of the EUR/USD pair in the coming weeks, based on continued uncertainty on all fronts; sharp contraction in eurozone growth, a possible Spanish bailout, Greek uncertainty and a continued imbalance between talk and genuine action. If EUR/USD heads down towards $1.21 as we expect, then this would almost ensure GBP/USD declines even if UK news is positive. Given that we expect news out of the UK to be negative, we feel this pair’s downturn could be quite aggressive. A move down $1.52 looks realistic in the coming weeks.

Richard Driver

Analyst – Caxton FX
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Weekly Round-Up: Sterling the new safe haven currency?

Merkel and Sarkozy offer little action


Last week’s meeting between Merkel and Sarkozy failed to provide any concrete action on the eurozone debt issue. The introduction of a eurozone bond was discarded as an option and the EFSF is not to be expanded. Vague commitments to common governance and a Tobin tax were the main results, neither of which inspired much confidence.

The euro is still trading fairly strongly tough, particularly against the dollar. This is largely attributable to increasing dollar-weakness and a degree of relief that the ECB are buying eurozone debt to stabilise peripheral bond yields.

US recession looms

The Philly Fed manufacturing index revealed an alarming contraction last week, intensifying speculation that the US economy is heading back into recession. The index gave its worst reading since the recession levels of March 2009. Global stocks suffered a major slide as a result, and riskier commodity-linked currencies sold off sharply, but the euro remains stable.

The US GDP figure is expected to be revised down by 0.2% to 1.1% (annualised) on Friday. Also on Friday is the key focus of the week, Fed Chairman Ben Bernanke’s speech. The prospects of a third programme of quantitative easing are improving with every poor piece of US data and Bernanke’s comments this week could be crucial for the dollar’s longer-term direction.

Sterling gains some safe-haven status

News from the UK economy was by no means positive last week. The monthly UK retail sales figure came in below expectations and UK unemployment data was particularly poor. In addition, the MPC minutes were very dovish indeed. The two remaining MPC hawks, Charles Bean and Spencer Dale abandoned their quest for higher UK interest rates and joined the rest of the 9 member committee in voting for an interest rate hold at 0.5%. This all but eliminates the chances of monetary tightening this year and pushes back bets towards the back end of next year, if at all.

Nonetheless, sterling is trading very strongly against both the euro and particularly the US dollar. Much of this is due to the pound receiving an increased share of safe-haven flows. With doubts over the US credit rating and building concerns of another US recession, as well as fears of currency intervention with regard to the yen and the swiss franc (major safe haven currencies), sterling has acquired its own haven status.
With the dollar likely to remain weak in the long-term, particularly if further QE is signalled by Bernanke on Friday, sterling’s prospects have improved significantly across the board.

There is plenty of risk with regard to eurozone data this week; we have a raft of PMI data released tomorrow, as well as forward-looking German economic sentiment and business climate data. The economic picture in Germany and the eurozone as a whole has taken a turn for the worse in light of last week’s poor GDP figures (0.1% and 0.2% respectively). If weak eurozone data puts eurozone debt back under pressure, then market nerves will rise once again.

Sterling is trading at $1.65 and €1.1450 at present. Risks on both pairings this week are to the upside, while the EUR/USD pairing should remain somewhere near current levels of $1.44.

End of week forecast
GBP / EUR 1.15
GBP / USD 1.66
EUR / USD 1.4430
GBP / AUD 1.57

Richard Driver
Senior Analyst – Caxton FX
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Fed monetary policy decision tomorrow: what's going to happen?

There is little pushing the Fed to tighten policy. The US is not suffering from the same price pressures as other economies and labour market improvement remains the Fed’s number one concern. Moreover, there have emerged serious question marks over the US economic outlook amid a raft of awful growth figures. The Fed and BoE policy outlooks are very similar; tighter policy can only be considered when sustained growth emerges. The threat of a double-dip recession in both economies remains realistic, and premature tightening could be the tipping point.

Accordingly, we are probably looking at the middle of next year for a Fed rate hike. Bernanke looks highly likely to maintain his “extended period” rhetoric with regard to the Fed’s current ultra-loose monetary policy. However, a third round of quantitative easing would probably only be resorted to if the US did fall back into negative growth. Bernanke is likely to stress the recent weakness of US growth and in the absence of any hints to future tightening, the US dollar looks likely to come under a little pressure. The dollar will remain weak for many months to come, but hopes for hawkish Fed rhetoric are so sparse that we are unlikely to see the greenback suffer any major losses for today at least.

Richard Driver
Analyst – Caxton FX
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Pound punches high with recovery looking promising

The pound’s run of good form against the greenback continued today, with the price being dragged up through $1.63 as comments from the BoE governor Mervyn King yesterday did little to dampen the markets view on interest rate speculation.

Sterling came within a whisker of a 13-month high today as King exhaustedly claimed that “raising interest rates to make a gesture is self-defeating.” This followed a rather more assertive Conservative MP who lambasted the senior MPC members for wildly underestimating inflation.

Charles Bean, the deputy governor of the MPC showed signs of leaning towards the hawkish camp by echoing this sentiment in a written statement to the Treasury select committee, exclaiming his concern that this elevated inflation may well persist longer than he anticipated. This contrasts with comments from Fed Chairman Ben Bernanke who claimed that soaring oil prices pose only a “temporary threat” to inflation, which indicated to the market that the Fed will persist with its ultra-loose, accommodative monetary policy for the foreseeable future. Under this outlook, the pound’s rally could yet go further!

The threat of inflation entrenching itself in the UK do appear very real, and hence we’re seeing the market price in a near-term rate rise. But are the arguments about the fragility of the economy still stacking up?

Recent figures suggest that the UK economy has rebounded strongly in the first quarter of 2011, offsetting Q4s disappointment. Positive data from the construction industry, released earlier today, followed equally upbeat manufacturing data earlier in the week. These two sectors combined account for around 20% of our GDP. If data from the services sector tomorrow completes the picture, the UK economic recovery will certainly look to be gathering some momentum.

As far as “cable” (GBP/USD) goes then, we could well be seeing these dizzying heights sustained, with the next tough resistance level seen at 1.6450. However, against the equally well-performing single currency the story may be slightly different. The market is expecting some hawkish comments on inflationary pressures from ECB president Trichet in the ECB press conference tomorrow. Such comments look set to keep the €1.20 level out of the picture for the time being. 

Ewdard Knox

Analyst - Caxton FX

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Sterling awaits Wednesday’s MPC minutes

With the calendar quiet on the data front, sterling has fallen by more than half a percent against the US dollar to trade just above the $1.59 level and has also lost ground to the euro, dropping below €1.14.

The pound has come off last week’s eight and a half month high against the greenback on doubts about how aggressive Federal Reserve monetary easing will be. There is also a sense now that Fed easing has been priced in leading some investors to cut their bets against that the dollar will decline.

The UK currency also remains vulnerable ahead of the publication of the latest MPC minutes and the UK government’s spending review, both on Wednesday. The review could increase speculation for more quantitative easing in the UK, and the BoE minutes could see a dovish move led by Adam Posen, putting sterling under further pressure. This all lends itself to the hypothesis that GBP will still have a little way to go towards the downside before things improve.

In other news, the outperforming aussie dollar made a move to beat parity against the US currency on Friday off the back of Bernanke’s speech where he outlined the Fed’s case for more easing, but has since dropped back to 0.99.

Tom Hampton
Analyst - Caxton FX

Bernanke for second term appointment

US President Barack Obama will nominate Ben Bernanke to a second term as chairman of the Fed today, seeking to retain his services in steering the world’s largest economy out of its deepest downturn since the 1930s. Bernanke’s appointment though will need to be confirmed by the Senate where he has faced criticism from certain lawmakers who feel that his policies of lowering the interest rates to near zero and flooding the financial markets with over a trillion dollars have been an over-extension of Fed support that will be difficult to unwind, threatening future inflation. However, most investors have given Bernanke, whose current term expires on January 31st 2010, high marks and widely anticipated his reappointment.