Sterling enjoys a major boost from hawkish BoE Inflation Report

Mervyn King took the market by surprise this morning by indicating that the Bank of England could raise interest rates this year. So, after a session on the back foot yesterday, sterling has spiked aggressively against most of its major counterparts today, gaining a cent on the dollar and well over a cent on the euro.
Before today’s Quarterly Inflation Report, pessimism surrounding the UK economy was such that no interest rate rise was fully priced in by the market until January next year. Investors now seem confident that we will see some monetary tightening by the end of this year. Why? Not because of a more positive view of the UK economy, that’s for sure. Indeed, King expressed concern that first quarter growth was slower than expected and that the UK’s near-term outlook moving forward was downgraded.

The UK’s inflation expectations were upgraded, with the figure likely to hit 5% in coming months and to remain above the BoE’s official target of 2% for the whole of next year. We have already been warned that inflation could reach these levels, so why the huge response?

It was the somewhat hawkish tone of King that seemed to seal it. King has been distinctly dovish in the past, and it seemed like he meant business today, “Bank rate will rise at some point, it cannot stay at this level indefinitely.” He also stated that his May inflation forecasts were based on the assumption that interest rates will rise to 0.8% in the fourth quarter of 2011 and to 1% in the early part of 2012. So, a 25 basis point hike is now fully priced in for December.

Views surrounding BoE monetary tightening range from two rate rises this year (with the first in August) to none this year, and none next. Not to be fence-sitters, but we are somewhere in the middle. Today’s sterling positivity has been overdone in our opinion, we are more cautious about the UK’s struggling recovery.

Particularly in the absence of arch-hawk Andrew Sentance , the MPC seems likely to remain in wait for growth to come before raising rates. The picture will be clearer if last month’s slow in growth is shown to be temporary, as King indicates, or reflective of an even more fragile recovery than initially recognised. What’s more, the MPC has shown little concern with accusations that its weakening grip on inflationary pressures is calling its credibility into question. So despite King’s hawkish tones we'd prefer to wait for further evidence before bringing interest rate expectations forward.

Comments, as ever are welcome!

Richard Driver

Analyst – Caxton FX


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A Modern Greek Tragedy

The euro has tanked in the last few sessions, it was pushing $1.50 last week but is trading down near $1.43 today. Why? Well, Trichet disappointed in his press conference, and a slide in global commodity prices contributed to an increase in risk aversion. But the Greek debt crisis is primarily responsible. So what’s going on?


It has been widely accepted that Greek debt has been at unsustainable levels for some time now, its bond yields are through the roof. Rumours circulated that Greece was mooting a euro exit, but these have been strongly denied by all Greek and eurozone officials. Nonetheless it seems the power that be have finally concluded that something needs to be done. Various options are available in terms of addressing the Greek debt problem, some softer and shorter-term, some far more unprecedented and risky. It looks as if a genuine restructure of Greek debt has been ruled out, rather its financial rescue plan is to be restructured.

Loan maturity dates could be extended, Greece could have their bailout loan interest rate cut, they could receive additional funding, debt could be written off, or a combination of these and other methods could be used (as explained in an FT Alphaville blog). Talks are taking place this week and we should know more by the middle of next week what is to be done. However, the question remains, are these bailouts working?

The only way these nations- Portugal, Ireland, Greece- can get out of trouble is through economic growth. The eurozone bailouts we have seen, as an Economist blog argues, do what is necessary to avoid total disaster, but little more. The Greek problem is evidence that the current bailout system does not work; Greece received aid - it had to make horrific spending cuts, tax heavily and incur much heightened borrowing costs, making growth impossible. So a year on from Greece’s initial €110bn bailout, Greece is knocking on the door once more.

Ireland could well need to follow Greece in adjusting its bailout plan and we have just seen Portugal request a fresh bailout. Who’s next? Spain is the obvious candidate but thankfully bond yields there are holding up OK, though they are still rising and who knows whether investors will lose their faith.

The bottom line is that growth in the periphery is essential for a genuine fiscal turnaround, and this seems unattainable under the current approach. But what is the alternative? Well, that’s for another blog...

Richard Driver
Analyst – Caxton FX

For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Trichet grabs the headlines

Today’s session was an exciting one; with key news from both the UK economy and two major central banks. UK services data for April showed a slow in growth, even slower than forecast, in addition to the poor UK construction and manufacturing figures that came this week.

Elsewhere, the ECB and the BoE kept interest rates on hold but as expected Trichet’s press conference stole the show. Trichet failed to include the phrase “strong vigilance” with regard to eurozone inflation levels; and this has triggered a pretty massive euro sell-off. GBP/EUR has gained by a cent on the news, and EUR/USD has come off by two cents. It seems that the market was really expecting a far more hawkish approach from Trichet today. A June ECB rate rise is now off the cards, but bets on July remain realistic.

So do today’s major movements change our outlooks? Well not really, we are still negative on sterling. Sentiment towards the UK economy is at its worst in a very long time; services growth was supposed to be the ‘banker.’ When this week’s poor data is put together with the UK’s ailing consumer confidence/retail sales figures, it paints a very grim picture indeed. Some are not forecasting a BoE rate rise until 2013!

It is difficult to see how sterling can continue its rally once the dust settles on Trichet’s comments; there just isn’t a catalyst for further sterling other than a freak upsurge in UK inflation. With arch-hawk Andrew Sentance leaving the MPC this month, the doves remain firmly in control.

Contributing to the euro’s fall today has been some poor German factory orders data and a fairly sharp increase in risk aversion ahead of tomorrow’s key US unemployment data; these factors will fade from focus so a euro/dollar climb back up towards $1.50 cannot be written off. Regardless of Trichet’s comments, the factors that took the euro so high remain in place.

As ever, comments are welcomed.

Richard Driver
Senior Analyst – Caxton FX


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UK Manufacturing Data Flops

The monthly figure for UK manufacturing growth has come in well below expectations and sterling has understandably plummeted as a result. Going into today’s session, sentiment towards the UK economy was tentative at best given last week’s first quarter GDP figure of 0.5%. Anything less than 0.5% would officially have put the UK economy back in recession.

The market would have been looking for a clean sweep of positive UK data this week, and this morning’s drastic undershoot only increases the pressure on growth elsewhere. With growth in services and construction expected to slow, risks are certainly to the downside on sterling.

The MPC will make its monthly rate statement on Thursday, and no change in the 0.5% BoE rate is anticipated. With arch-hawk Andrew Sentance set to leave the MPC this month, a BoE rate rise this summer is looking increasingly unlikely.

The ECB is also making its monthly rate decision on Thursday, and whilst the market consensus is that it will follow last month’s rate hike in June, there is a small chance it will tighten policy again this week. Eurozone inflation is well above the official target, and the ECB (unlike the BoE) has shown it is more concerned with maintaining price stability than with safeguarding economic growth. In all likelihood it will be Trichet’s press conference on Thursday that will hold focus, as the market looks for firmer indications that the ECB will raise rates again next month.

Having fallen through robust support levels against the euro at €1.12, sterling looks highly vulnerable to further losses this week. Moreover, it is difficult to pinpoint a catalyst for a sterling turnaround unless this week’s figures show some unexpected growth.

All eyes are on tomorrow morning’s UK construction figures then. Sterling is in dire need of a surprise acceleration in growth. As always, comments are welcomed.

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Prospects for US dollar go from bad to worse

The fortunes of the US dollar have taken a severe knock over the past 24 hours. In the first press conference the Fed has given following an interest rate announcement, Bernanke took on a decidedly dovish tone towards the outlook for the US economy. In addition to downgrading the growth forecast for 2011, Bernanke reiterated that any potential spike in inflation will likely prove temporary, leading investors to pare back any forecasts for an interest rate rise this side of 2012.

Also weighing on the dollar, Bernanke found his growth downgrade vindicated after data revealed a disappointing GDP figure. On an annualised basis the US economy grew by 1.8% in the first quarter of the year, lower than the consensus forecast of 1.9%, and revealing a marked slowdown from the 3.2% seen in the final three months of 2010.

In response, the market has undertaken a fresh wave of dollar selling over the past couple of sessions, leading the Dollar Index to fall to its lowest level since 2008. The Australian currency hit a fresh post-float high, and both the euro and sterling reached multi-month highs. Looking ahead there appears to be little on the horizon to offer the greenback much support. Even the increasingly rare bouts of risk aversion appear to be favouring the Swiss franc over the dollar.

The problem comes down to loose monetary policy, plain and simple. The Fed is behind the interest rate curve – and by some way. Even though Bernanke’s statement did indicate that QEII will end in June (as widely expected), the market has little reason to stay invested in the currency. Risk appetite is high (regardless of the time bomb that is the eurozone), global growth prospects are improving, and the insatiable desire among Eastern sovereigns to diversify away from the world’s reserve currency remains firmly in place.

It looks now like the euro will go on in the proceeding weeks to hit $1.50, and close on its coat tails I wouldn’t say that $1.70 for the pound is out of the realms of possibility. Barring any serious left of field shocks (a Greece debt restructuring is still unlikely in the medium term despite some well constructed arguments suggesting that they should), the greenback’s downtrend will not let up.

With the economic stuff out the way – I wish you all a fantastic long weekend. Here’s hoping the Royal Wedding lives up to unprecedented media hype....

Senior Analyst – Caxton FX
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UK GDP gives sterling a glimmer of hope

It’s been a long time coming, but the UK’s first quarter GDP figure was released this morning, revealing a growth figure of 0.5%. This put it bang in line with consensus – a surprising fact in itself – which proved sufficient to give the ailing pound a much needed nudge higher.

When broken down, the figure is relatively encouraging. Had it not been for a disappointing construction sector reading, the figure may have been substantially higher with both manufacturing and services on a firm footing in the opening three months. From sterling’s perspective the key focus is whether the GDP data will swing any MPC voters across to the hawkish ‘let’s raise interest rates’ camp.

Unfortunately, I think this is still some way off. Taken together with the previous quarter, the UK economy has not grown in the past 6 months (albeit it hasn’t contracted either). I doubt that the dovish leaning members of the MPC will take too much encouragement from that fact. A sustained run of stronger economic signals needs to be seen before we can rekindle hopes of a summer interest rate rise.

Nonetheless, sterling has recovered from its pre-release lows. Owing to rumours of a much lower GDP number, the pound has only managed a recovery to just short of €1.13. Looking ahead however, we have reason to suggest that the pound has found its elusive bottom. Sterling may still be some way from embarking on a steady recovery, but I don’t think we’ll see any fresh lows set.

Upward momentum from here will be decidedly protracted. In broad terms, the UK currency is still out of favour and the euro remains seemingly untouchable. Even amid a growing chorus surrounding a Greek debt restructuring, the euro is holding steady, plugging fresh 15-month highs against the US dollar. However, the pound is hugely undervalued and with a few more encouraging figures, sentiment should begin to swing. The standard monthly PMI figures are due next week (services, manufacturing, and construction sectors) and will provide the first signs of economic health in the second quarter.

Whilst this blog has focused on the pound’s fortunes against its multi-nation neighbour, it must be noted that sterling is making consistent gains against the US dollar – the worst performing G20 currency at present. Clinging tight to the coattails of the euro/dollar pairing, we could yet see $1.67!

Over or under valued?

The pound is trading near six-month lows against the euro; the Australian currency is at post-float highs against the US dollar; and the euro is also at 15-month highs against the greenback. Most would agree that these levels – as well as many other pairings at present – do not reflect fair value. However, there is a great deal of benefit to be had in the longer term from having an undervalued currency.

A weak currency provides a real boost to the country’s exporters and this has been targeted as a key route to recovery by many global economies, in particular the UK. Britain needs to rebalance its economy and in the longer term a weak currency should encourage that process. Unfortunately it also exacerbates inflationary pressures, but there can be little doubt that over a longer time frame, the British economy stands to benefit from a lower pound – even if that isn’t immediately apparent for those heading abroad this Spring!

The US dollar is also very weak at present, and this has become the subject of some debate. As a major importer, the US does not necessarily stand to benefit from a weak currency and indeed the Fed has reiterated its commitment to a strong dollar. Its market value tells a different story however, and the greenback is unlikely to claw back losses until the Fed take steps toward tightening monetary policy.

The Chinese yuan has been at the heart of the ‘currency wars’ debate. The Chinese export sector has been booming on the back of a hugely undervalued yuan, much to the consternation of other countries. With inflation particularly high in Asia, China is now beginning to allow the steady appreciation of its currency, but this will be a slow process. China can ill afford to slow its rate of growth too drastically.

The countries that have shown extraordinary resilience to the strength of their currencies include Canada, Australia, and New Zealand., which have all reached multi-year highs against the US dollar in recent months. This strength, though warranted, is far from supportive for the economy and Canadian policymakers in particular have expressed their concern. We’re certainly unlikely to see any material intervention in the market to curb this strength, but comments talking down the currency should have the same effect.

In the case of Australia, such is the demand from China’s booming economy that exporters appear capable to withstand the strength of the aussie dollar. High levels of risk appetite combined with soaring commodity prices look set to keep higher-yielding currencies well-supported throughout year. Indeed the aussie and kiwi dollars could have even further to climb in the short term; who would want to bet against them frankly? These currencies may well be overvalued, but a turnaround in trend remains a distant prospect at best.

Richard Driver

Senior Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Weekly round-up: Euro at dizzy heights.

Eurozone debt concerns fail to dent euro strength

The euro has once again managed to shake off considerable concerns surrounding debt problems in the periphery. An unprecedented Greek debt restructure now looks a matter of time, and further uncertainty over Portugal has surfaced following the success of a euro-sceptic party in a Finnish parliamentary election. Peripheral bond spreads are continuing to widen as a result, and yet the euro has hit multi-month highs against both sterling and the US dollar in recent sessions. The determination of major sovereign accounts to diversify away from the dollar despite very real debt problems never ceases to amaze.
MPC minutes disappoint but UK retail sales provide hope

Last week’s minutes revealed that the MPC is no closer to matching the ECB’s April interest rate rise in the near future. As expected, the voting pattern within the committee remains unchanged and allusions to the UK’s weak output and uncertain recovery disappointed investors. The MPC is clearly waiting for firmer evidence that the UK recovery is assured before tightening policy.

Contrary to expectations, we saw some surprising (if only slight) growth in monthly UK retail sales, an indicator that a balanced UK recovery is at least in sight. Nonetheless, a series of positive figures from the consumer/retail side will be required in the next few months if the MPC is to be convinced to pull the trigger on a rate rise.

Sterling to gain in a shortened week

There are only three working days for UK markets but there are still some key announcements to navigate this week. The UK economy will again be in focus with first quarter UK GDP announced this Wednesday. The prospect of a BoE rate rise this summer - and therefore sterling’s short term direction - hangs on a decent figure.

Last quarter saw UK output contract by half a percent; the hopes of a sustained sterling recovery depend on growth rebounding by no less than market expectations (0.6%). At present the market is pricing in a November rate rise from the BoE, which contrasts fully with consensus that the ECB will again tighten policy as soon as June. However, these BoE rate expectations could be brought forward with the help of a solid UK GDP data.

Further dollar weakness

As risk appetite seems to increase with every week that goes by, the US dollar is falling further out of favour. Sterling currently trading at a 17-month high against the greenback and the aussie has hit a fresh post-1983 high. With the dollar-funded carry trade very much on the scene, particularly within the context of the Fed’s quantitative easing programme, the US currency’s downtrend looks set to continue for weeks to come.

An update on US policy is due on Wednesday evening and the market will be looking for indications that the FED’s QEII programme will end in June as originally planned. However, we’re unlikely to hear anything just yet that alludes to higher interest rates in the US, which should keep the US dollar pinned back. Preliminary US quarterly GDP data rounds off a shortened week. Signs suggest a decent figure, but we’re not expecting this to be the catalyst for any US dollar turnaround with risk appetite on top.

For those of you taking holidays to Europe this Easter period, the GBP/EUR has come in your favour considerably today (though it remains at low levels unfortunately). Caxton FX can currently offer you €1.1120 on our prepaid currency cards if you want to avoid those withdrawl fees. Either way, have a great break!

Comments, as ever, are always welcome.
Richard Driver
Analyst – Caxton FX

For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Bank of England Minutes disappoint- sterling takes a tumble

Sterling has slumped badly against the euro today in the wake of the MPC’s minutes, which were received particularly poorly by the market. We might wonder why the response has been so strong given that no one actually expected to see an additional MPC member vote in favour of an interest rate rise.

The thing that has disappointed investors today is the dovish tone of the minutes. The BoE’s priorities have yet again been made clear; UK growth must come before they hit consumers with higher borrowing costs. Allusions to “an uncertain economic outlook” stuck out like a sore thumb. The wait-and-see mode stands firm, and last week’s fall in UK inflation has put the doves back in control.

Data has been mixed over the past month or so; manufacturing and services data was encouraging but the retail and consumer confidence side remains at very low levels. UK monthly retail sales data will be released tomorrow, good news is not expected but it is badly needed if sterling’s fortunes are to improve.

Next week UK first quarter GDP is released; without a steady figure here the sterling could have further to drop. The market has now pushed back expectations of the next BoE rate rise to November. Compare this to expectations of another ECB rate rise in July and you can see why sterling is at such low levels against the single currency.

Market thinned markets have also exaggerated sterling’s drop against the euro.

The move has also come amid an already euro-positive correction of Monday’s wave of risk aversion. However, on a more positive note for sterling, the minutes do suggest that last month’s surprise drop in inflation was just a blip in an uptrend that is likely to see CPI exceed 5% this year. If UK growth does improve in coming months, then amid such price pressures we could yet see expectations of a BoE rate rise brought forward to the summer. One thing seems clear though, any decent sterling/euro rate (say…1.18), seems a very long way away indeed.

Comments are always welcomed.

Richard Driver
Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

With all this talk about America’s AAA rating – Is the world’s largest economy breaking down?

Okay, the rating agency Standard & Poor’s did not actually downgrade America’s AAA credit rating, but we had to make the pun work. Nonetheless, the news that S& P has downgraded its outlook for the US economy from stable to negative is still quite astonishing. Perhaps even more so as the US is showing signs that its economy is recovering quite impressively in many areas; so what has brought this criticism on?

Quite simply, the US trade deficit is enormous. Last Tuesday, it was announced that the US trade balance showed a -$45.8B deficit, well above forecasts. The argument is that this level of public finance deficit is simply not sustainable even for an economy as strong as the US. Adding to this problem is the fact that the opposing political bias between the Senate and Congress means that attacking the problem with any degree of efficiency or success is proving very difficult. As an FT Alphaville blog notes, the US political impasse may last until next year’s Congressional elections, and an appropriate budget will probably arrive late in 2013.

In a Forbes blog, S & P’s move was described as a “false alarm.” But as is later noted, this is only the case if the market is convinced of this fact. If the market gradually considers US Treasuries to be a riskier asset on the back of such rating agency scrutiny, then the US will be paying a much higher premium for its considerable debt. We’re inclined to agree that the market will not lose confidence in the US economy on the back of S & P’s analysis. However, if more follow then the picture changes dramatically.

From a foreign exchange point of view, the US dollar has actually benefitted from the rather gloomy outlook for the US economy. For those of you that followed the yen’s movements in the aftermath of the recent Japanese crisis, this will not come as a huge surprise. The dollar remains a safe-haven currency (though its status as such has come into question in recent months), and so in a time when the world’s largest economy has come into question, investors will flee to safety. Risk appetite will return after the Easter period, and our medium-term view of a weaker dollar remains unchanged. However, unlike S & P, this is based on the Fed’s ultra-loose monetary policy rather than a weaker outlook for the US economy.

As always any comments are welcome, feel free to disagree!
Richard Driver
Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.