April 2013 Outlook: Sterling edges higher as debt crisis resurfaces

After an awful start to the year, sterling has benefited from a welcome boost on the exchange rates in recent weeks. A couple of positive domestic economic developments have helped matters but events in the eurozone have been the key driver, helping to put the UK’s troubles in perspective. Domestic growth data in March did little to significantly improve the outlook for the UK recovery, though a couple of bright spots have provided a much-needed source of hope. There has also been a lack of further dovish leanings within the Bank of England, though we do expect more QE to be announced in May.

There was a collective sigh of relief that Cyprus avoided an unprecedented euro-exit and more

importantly that the eurozone banking system avoided the shockwaves which would inevitably follow. Nonetheless, events in Cyprus have understandably shaken the euro in the past month. The bailout deal that Cyprus reached with the Troika will leave the country deep in recession for a long time to come but this won’t be the market’s primary concern. Alarm bells are ringing following mixed rhetoric from within the EU leadership over whether the “bail-in” – where private investors and depositors, not taxpayers footed the bill for the refinancing – represents a special case or not. Some dangerous precedents have been set and with other larger eurozone strugglers such as Portugal and Italy exhibiting some tell-tale signs of crisis further down the line, the euro could be set for a troublesome few months.

GBP/EUR

Cyprus has investors fleeing for safety

Sterling looks to have bottomed out against the euro for the time being. The wave of anti-sterling sentiment has abated for now, amid a feeling that most of the bad news is already out in the open with respect to the UK economy. If the last few weeks have taught us anything, it’s surely that all the bad news is certainly not out in the open with respect to the eurozone.                      

                            

The pound emerged from the Annual Budget more or less unscathed, despite Osborne revealing that the Office of Budget Responsibility has slashed its 2013 GDP expectations from 1.2% to just 0.6% (which will most likely be undershot). Osborne effectively passed the buck to the Bank of England in terms of efforts to stimulate UK growth, directly expanding its mandate to that effect.

The latest from the Bank of England is that Mervyn King and his two fellow doves (Fisher and Miles) remain in the minority on the key quantitative easing debate, with the other six members seemingly too concerned with rising UK price pressures. In addition, the March MPC minutes revealed that there were fears surrounding an “unwarranted deprecation in the value of the pound,” which will concern many of those betting against the pound. We feel safe predicting that there will be no dovish majority in favour of QE in this Thursday’s MPC meeting, though we see a probability that we will see the voting swing in favour in May.

UK Q1 GDP figure comes into focus

Growth in the UK clearly remains very weak indeed. February’s data revealed the worst monthly construction growth in three years, whilst manufacturing is also firmly in contraction territory. Gladly, there was some relief in that the dominant UK services sector posted its best figure in five months and February’s 2.1% retail sales growth was excellent.  However, the key issue of whether or not the UK economy will avoid a triple-dip recession, when its Q1 GDP figure is announced on April 25, remains finely balanced. The March PMI figures released over the coming sessions will be highly significant; this morning’s manufacturing update got things off to a weak start but as ever, the pressure will be on Thursday’s services figure to deliver again.

Dangerous precedents will hurt the euro

While, there have been some rare sources of positivity with respect to domestic developments, this pair’s recent climb is explained mostly by events in the eurozone. Cyprus stole the headlines; the dreaded euro-exit has been avoided once again but the market has been left with some rather uncomfortable lessons. In a fundamental shift in eurozone banking relations, private individuals and companies with large amounts of cash in European banks now find themselves at risk of other potential ‘bail-ins’ in other struggling nations. This new credit risk is likely to leave a major psychological mark on euro-depositors and will have many heading to the exits and targeting perceived safer options like the GBP and USD.

Where will the next debt crisis hotspot be? Italy is looking a decent bet. Political instability is not the only issue the country faces, economic contraction remains a major issue and perhaps more pressingly, the health of Italian banks is deteriorating at an alarming rate. If things continue at this rate then Italy could find itself in a similar position to Cyprus, in need of recapitalising its banks, with Germany opposing a fix-all bailout from the European Stability Mechanism.

Some dangerous precedents have been set in Cyprus in terms of depositors being forced into a ‘bail-in,’ senior bondholder suffering haircuts, major and extended capital controls being implemented, the ECB imposing strict deadlines on their liquidity provision. Lines in the sand have been drawn, which are fundamentally likely to undermine confidence in the euro.

Debt crisis to one side, eurozone data has remained disappointingly true to its downtrend.  Monthly growth data from Spain, France, Germany and the eurozone as a whole has all undershot expectations, which suggests that Draghi is being more than a little overoptimistic with respect to his expectations that the region’s recession will stabilise soon. Naturally, events in Cyprus have hurt confidence and sentiment gauges.

Sterling has recently posted seven-week highs of €1.1890, although this pair currently trades over a cent off this level. We do see GBP/EUR recovering further in the weeks ahead, particularly if the BoE delays QE this month and the UK services figure is solid. Asian reserve managers already appear to be responding to eurozone developments by taking a step back from the euro. We see this trend continuing, which could take this rate as high as €1.20 in the weeks ahead.

GBP/USD

Sterling finally enjoys a bounce

There is no doubt that sterling’s safe-haven status has waned in recent months, in line with the loss of the UK’s AA credit rating. It has therefore been no surprise to see the USD benefit from the lion’s share of safe-haven currency flows stemming from increased tensions in the eurozone. Nonetheless, the pound has managed to eke out some gains in the past three weeks or so, despite the uptrend in US economic figures.

Those economic figures have revealed a particularly strong increase in US retail sales and industrial production. However, with housing market data mixed and consumer sentiment gauges indicating some weakness, there remains more than enough cause for concern to see the Fed continuing with QE3 for the time being. Indeed, the Fed recently downgraded its 2013 GDP projections in anticipation of a fiscal drag later this year.

More improvements in US labour market

As ever analysis from inside the Fed and therefore throughout the market, will focus on the US labour market, from which the news has been distinctly positive over the past few weeks. The US unemployment rate dipped back down to 7.7% in February- its lowest level since February 2009, while the headline figure revealed 236,000 jobs were added to the payrolls – the biggest monthly increase in a year. There is plenty here to fuel the Fed hawks’ calls for scaling back QE3 but the bottom line is that Bernanke and his fellow doves still require further progress. They may well get what they want as this Friday’s key US labour market update once again promises to be robust.

There were some notable phrases within the Fed’s March statement, among which was the emphasis that the central bank has the ability to vary the pace of QE3 in response to changes in the US economic outlook. So it really does seem as if they are gearing us up for fazing QE3 out, though this remains conditional to labour market progress.

Sterling may well face some short-term weakness if the UK services figure disappoints and there is room here for a move down to $1.5050. However, our baseline scenario is for a further upward correction for this pair. A move up towards $1.55 is possible in the weeks ahead, though this comes with the caveat that the UK must avoid a triple-tip recession (no sure thing). Beyond this near-term upward correction, we maintain a negative outlook for this pair in H2 2013, in line with our positive outlook for the US dollar.

GBP/EUR: €1.20

GBP/USD: $1.53

EUR/USD: $1.27

Richard Driver
Analyst – Caxton FX

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Caxton FX Weekly Outlook: Things looking up for GBP

Cyprus does what’s necessary but the market remains wary

Cyprus has agreed a deal with the Troika which will see them receive urgently needed loans amounting to €10bn. Though the measures that are part of the deal are likely to leave the country in a prolonged economic depression, disaster has been avoided as far as the wider implications of a euro-exit are concerned. Eurozone-wide contagion appears to have been avoided, for now at least.

The country’s second largest bank, Laiki Bank, will be wound down, with its ‘good assets’ becoming part of the Bank of Cyprus. Large depositors are likely to be hit and hit hard, possibly facing losses as high as 40% - much to Russia’s chagrin. In response, Russian PM Medvedev has bitterly questioned the role that the EUR is to play in Russia’s currency reserves, though we don’t attribute much substance to this.

The deal certainly hasn’t triggered a relief rally for the euro, quite the opposite in fact. Meanwhile, data from the eurozone has been poor again in the past week. The French, German and overall eurozone PMI updates for March made for a sea of red. The recession in the region is deepening and it is a concern to see German manufacturing dipping back into contraction territory. Once again, this really puts the UK’s weak figures into some perspective; we are not the only ones struggling. Unsurprisingly, the latest German business sentiment update has also been hit by events in Cyprus.

MPC minutes trigger some sterling positivity

Last week’s minutes blew the dust of some genuine sterling demand, which was unexpected given the state of UK economic updates over the course of February. Mervyn King was unable to add to the 3-member faction of doves with the MPC, while perhaps even more significantly the minutes noted a desire to avoid “an unwarranted depreciation in the pound.” Added to this, the UK retail sales figure for February was excellent, revealing 2.1% growth, which more than made up for January’s snow-hit start to the year.

The Fed’s QE3 outlook remains unclear

We know that the US recovery is taking decent shape and we know that there is a substantial body of opinion within the Fed that wants to begin winding QE3 down. However, we also know that Bernanke remains cautious and needs to see further substantial improvements in the US labour market. Nonetheless, Bernanke does appear to be setting the stage for an eventual reduction in the pace of Fed asset-purchases, which should be a source of dollar-strength by the summer.

End of week forecast

GBP / EUR	1.1875
GBP / USD	1.5200
EUR / USD	1.28
GBP / AUD	1.45

The pound is looking a little firmer across the board in light of positive domestic developments and ongoing tensions in the eurozone. Against the USD, we now see the recent dip below $1.49 as a temporary base from which it will continue mounting a recovery. Losses in the EUR/USD pair are likely to make it slow and limited progress on the upside, but we do expect GBP/USD to see levels closer to $1.55 in the coming weeks. The picture for GBP/EUR is also looking a little brighter, with a test of February’s highs above €1.18 a very likely development in the near-term.

Richard Driver

Currency Analyst 

CaxtonFX

Bumper UK retail sales data provides some hope for sterling

Data this morning revealed that UK retail sales grew by a whopping 2.1% in February, which is an excellent result, particularly given the dire economic figures that have surfaced over Q1. This is the biggest monthly increase in three full years. Clearly plenty of this can be attributed to a natural recovery from a fairly empty high street in January as a result of the snowy weather. However, the strong showing can’t be entirely attributed to a bounce back and driving the growth in particular was strong demand for computer tablets, sporting goods and jewellery.

We can expect an overall improvement in UK retail sales over Q1 as a whole, which should enable the UK to avoid the dreaded triple-dip recession when the GDP data is released on April 25. In turn, this may well ensure that Mervyn King, Paul Fisher and David Miles remain the three doves voting in favour of QE at next month’s MPC meeting. That certainly doesn’t mean more won’t be convinced by May, which is an important Inflation Report month.

Yesterday’s UK Annual Budget provided a little bit of help for UK households in the form of a scrapped increase in fuel duty. However, real wages are still on a downtrend and UK inflation has also ticked higher lately, so we can be pretty confident that this morning’s UK retail sales won’t be replicated any time soon. Still though, good news is good news and sterling has benefited from it today. GBP/EUR is trading at €1.1750, only marginally lower than its highest level since Feb 10. Against the US dollar, sterling is trading close to the top of its one-month trading range, having just edged half a cent lower from $1.52.  

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Analysis: Cyprus hits the markets

Cyprus uncertainty weighs on the market

The weekend headlines out of Cyprus have given the market plenty to consider after what has been an increasingly troublesome few weeks for the single currency. The issue of a Cyprus’ bailout needs is not a new one but what took the markets by surprise is the fact that the plan includes proposals for savings in Cypriot bank accounts to be taxed by as much as 9.9%. Equities knee-jerked lower and the euro also came under pressure, while tensions have understandably increased in the bond markets.

A parliamentary vote on the proposals has been delayed until today at 16:00 GMT. We are likely to see the tax proposals – 6.75% on deposits up to €100k and 9.9% on €100k and above – diluted to a significant degree, with greater emphasis on safeguarding less wealthy depositors. The latest reports suggest deposits up to €20k will be untouched. Whether or not Cypriot MPs will vote in favour of whatever plan emerges is highly uncertain, given President Anastasiades does not enjoy the luxury of a parliamentary majority.

The ECB has been quick to reassure us that Cyprus represents a special case and this does not mean, for instance, Italian and Spanish depositors face similar taxations risks. For those with the luxury of being able to safeguard themselves by parking their funds elsewhere – in a German account, for example- capital flight would seem an intelligent option. However, a widespread bank-run in larger nations would not be our central scenario.

As usual there are more questions than answers but the one thing you can take away from developments in Cyprus, that confidence in the euro and more specifically the banking union will have been undermined.

Good chance of another MPC vote in favour of QE

We know that Mervyn King failed to convince the two extra voters he needed for a pro-QE decision at the MPC’s monthly meeting a fortnight ago. However, what we don’t know is whether he managed to take the vote to a 5-4 split. We expect Wednesday’s MPC meeting minutes to reveal that he did, with Paul Fisher looking the most likely candidate to have drifted into the dovish camp. If this is true and the MPC has edged that little bit closer towards QE, then expect sterling to come under some pressure. Today’s UK inflation figure came in higher at 2.8% but we doubt this will deter the MPC from topping up its QE operations.

George Osborne’s Annual Budget announcement could also take the wind out of sterling’s sails tomorrow. Growth expectations are likely to be downgraded and based on his track record, you would have to be pessimistic on the probability of the Chancellor announcing the convincing growth-boosting measures that the UK economy is crying out for. The Budget will likely serve as an unwelcome reminder of the awful state of UK growth and sterling may struggle as a result.

End of week forecast

GBP / EUR	1.16
GBP / USD	1.4950
EUR / USD	1.29
GBP / AUD	1.4450

The pound has been given a helping hand against the euro, reaching a five-week high of €1.17, though it trades a quarter of a cent lower than this now. We suspect this pair will give back some of this latest rally with the MPC minutes and Annual Budget in mind, though this pair’s lows around €1.1350 look safe for the time being. Much depends on headlines out of Cyprus in the very short-term. Against the US dollar, sterling is in slightly better shape up at $1.51. However, we remain sceptical as to the scope for further sterling gains, given the lack of any real sterling-positive news. 

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Round-Up: USD flying high

No QE from the BoE…yet

In a week packed with central bank announcements, the Bank of England’s MPC decided against topping up its quantitative easing operations. Mervyn King remained in the minority then, which was a surprise in itself and suggests his influence is waning ahead of his summer exit. Sterling only benefited from a brief spell of relief, which tells you all you need to know about how confident most market players are that the BoE will pull the trigger on QE at some point in the coming months.

February’s UK PMI growth figures were bailed out by a better-than-expected services sector figure, which probably played a significant part in convincing the majority of MPC members to keep their powder dry with respect to their QE votes. Still, as will likely be shown by tomorrow’s UK GDP estimate, it remains touch and go as to whether the UK triple-dip recession will be avoided. Tomorrow’s UK manufacturing and industrial production figures also look unlikely to kick-start sterling demand, with only very meager growth expected from the two sectors in January.

We are confident the MPC will be forced into action in the next few months as far as QE is concerned, though having paused in March, they may be convinced to wait until May, by which time they will have confirmation of the UK’s Q1 GDP figure. UK trade balance data could also be disappointing tomorrow morning, with producers reporting a lack of new export orders, despite the plummeting value of the pound. 

Draghi not so dovish despite weak eurozone output

We continue to see a disparity between the hard data that is coming out of the eurozone – watch out for Wednesday’s eurozone industrial production figure, which will likely show no growth – and the improving eurozone confidence levels. Still, Draghi sounded in confident mood in his monthly press conference last Thursday. He was hopeful that the eurozone recession would stabilize in the first half this year and perhaps even begin a recovery later on in the year.

Despite events in Italy, sentiment towards the euro is actually holding up pretty well at present then, which leads us to believe there is unfinished business with GBP/EUR’s low down towards €1.1350. We could well see this level revisited in the sessions ahead, though a major push below this still looks a stretch.

US unemployment data pushes the USD higher still

The greenback is loving life thanks to further domestic economic improvements. The US unemployment rate dropped to 7.7% and we saw a major hike in news jobs in February. The US recovery is far from “out of the woods” territory but things are definitely looking up and the greenback is benefiting as a result.  2013 is shaping up to be a bumper year for the USD.

End of week forecast

GBP / EUR	1.1350
GBP / USD	1.4770
EUR / USD	1.3000
GBP / AUD	1.4500

We envisage further weakness in the GBP/USD pair. Tomorrow’s slew of UK data, which looks likely to disappoint, could see sterling stoop to areas close to $1.4770. Meanwhile, EUR/USD is still threatening to move below the $1.30 level. GBP/EUR is also looking vulnerable, with €1.1344 a potential target in the coming sessions.

March 2013 Currency Report: Italy highlights euro vulnerabilities

 It was a case of more of the same for the pound in February; it posted fresh multi-month and multi-year lows against a host of currencies. Domestic growth data has consistently disappointed and as a result there has been a significant shift in rhetoric from the Bank of England, which is sounding more dovish than ever. The Monetary Policy Committee looks highly likely to set aside concerns over the UK’s higher inflation outlook and focus once again on kick-starting the recovery with further quantitative easing, perhaps as soon as this month. With UK data unlikely to inspire much confidence in the weeks ahead and Moody’s having finally downgraded the UK’s AAA credit rating, there is little domestic news that seems likely to come to GBP’s support. However, to an extent all the bad news is out in the open as far as sterling is concerned, which really isn’t the case with other currencies like the euro.

As seen in the aftermath of the recent worrying Italian election result, sterling will still benefit from rising demand amid periods of eurozone panic. This really is likely to prove the key if sterling is to turn its fortunes around because when market sentiment is stable and risk appetite is in play, GBP looks in poor shape. Given recent developments, it won’t come as much of a surprise that Italy is likely to be the focal point of eurozone tensions in the coming weeks and months.

We are some way from knowing whether an Italian coalition government can be formed, or whether a fresh election will have to be called. Neither scenario is likely to produce a very convincing end-result in terms of maintaining Italy’s commitment to economic reform, so we could well be entering a fairly lengthy period of market uncertainty. This should at halt GBP/EUR’s decline and could yet instil sufficient euro-negativity to trigger a sustained bounce.

GBP/EUR

GBP/EUR finally stops the rot

The pound’s dire start to 2013 continued in February, amid negative economic news, rating agency action and ultra-dovish commentary from our friends in the Monetary Policy Committee. Taking a look at the economic data to begin with, the UK PMI figures have far from eased concerns. A weak set of January figures was put down largely to the impact of the snowy weather. However, February’s manufacturing and construction updates were shockingly poor and hopes are not high for tomorrow morning’s services figure.

Moody’s finally wielded its axe in the direction of the UK’s AAA credit rating, the result of which was a two cent knee-jerk lower (though this was quickly recovered). We shouldn’t have to wait too long (perhaps a couple of months or so) before Fitch and S&P have followed suit but this doesn’t pose much of a threat to sterling in our view. The first move was always likely to be the most damaging and even this didn’t produce a sustained sell-off – the news will now be fully priced in. George Osborne seems set to stick to his guns with respect to austerity, though more details will emerge in this regard when he delivers his March 20^th Spring Budget.

More QE likely from MPC

On the monetary policy front, we have an extremely interesting week ahead. The MPC meets on Thursday and we are now expecting a majority decision in favour of quantitative easing. The shift in dovish rhetoric has been pretty drastic in recent weeks. First of all and significantly, last month’s MPC meeting minutes revealed that Mervyn King and Paul Fisher voted in favour of more QE in addition to the previously lone dove David Miles. In his ten years in office as Governor of the Bank of England, only four times has King been in the minority and each time he has found himself in the majority soon after, such is his influence. We expect the same to be true this time.

Last month’s UK inflation report downgraded economic growth prospects and recent data has been surprisingly weak, which suggests now is the time for emergency action. In addition, there has been plenty of rhetoric with respect to a more flexible approach to UK inflation. In other words, the MPC has made its peace with the fact that UK inflation will be well above target for the next three years but boosting UK growth is more important. This means more QE. If the MPC do not decide in favour of QE this week, we’d be surprised if we had to wait beyond May.

Italian elections shake the markets

From the eurozone, Italy has finally given the market reason to pause and question whether the euro really should be the ‘hot pick’ that it has represented over the past six months. A messy election result has produced more questions than answers as to what is next in terms of Italian government. Bersani’s Democratic Party failed to secure a parliamentary majority with Berlusconi’s centre-right coalition making a late surge into second place. Meanwhile, comedian-turned-politician Grillo’s anti-austerity 5 Star Movement came in third, which shows what Italy thought of Monti’s pro-austerity tenure.

Both Berlusconi and Grillo achieved blocking minorities in the Senate. Bersani has rejected the most obvious path of a grand coalition between his party and Berlusconi’s, while Grillo has ruled out offering Bersani his support. Bersani seems intent on forming a government on his own but the chances of another election later on this year look very high indeed now. The bottom line is that Italian efforts towards economic reform and debt-reduction will likely fall back, which should see pressure in the bond markets rise in the months ahead.

On the data front, actual eurozone growth indicators have failed to track improvements in confidence figures. Sentiment gauges out of Germany have been very encouraging indeed but manufacturing and services growth data from the powerhouse economy were disappointing in February, as they were from France and the eurozone as a whole. As shown by this week’s poor eurozone consumer confidence figure, concerns over Italy are likely to weigh for some time now. On top of these weak Q1 figures, data confirmed that almost all eurozone nations contracted at a sharper rate than expected in Q4 2012 – Germany included. Eurozone growth will clearly remain a concern for the European Central Bank but we do not expect an interest rate cut for at least the next few months, though the risks of a cut this year are rising with every month of economic contraction.

There remains a host of other eurozone concerns, from Cyprus’ bailout needs to Portugal’s demands for a renegotiation of its bailout terms, and plenty more besides. Regardless, sterling is seeing a diminished share of the safe-haven flows. Sentiment towards the UK economy remains extremely and unsurprisingly weak, which means we cannot discount another test of February’s lows around €1.1350 in the short-term. On balance, we would expect those lows to hold firm and for this pair to avoid any further major declines in the coming month. In fact, another visit to the €1.1835 high we saw a month ago is still a very realistic target once the dust has settled on this week’s weak UK growth figures and probable QE top-up.

GBP/USD

Greenback still on the up

This pair’s February and year-to-date charts are very ugly indeed as far as sterling sellers are concerned. Growth data has been very disappointing and we cannot discount a triple-dip recession. Moody’s downgraded the UK’s triple-A credit rating and the MPC has been particularly dovish, to which the market has responded by pricing in a pro-QE decision this Thursday.

Meanwhile, the US dollar has been very dominant indeed right across the board, not just against the pound. Firstly, there was positive economic news in the form an upward revision to the initial US GDP figure for Q4, which indicated a contraction. Some meagre growth has now been reported from a rather stagnant end to 2012, which was dominated by concerns over the US fiscal cliff. Data from the US in February remained on an uptrend by and large; consumer sentiment, housing data and manufacturing growth provided some highlights. There are well-placed hopes for a firm rebound in Q1.

Bernanke remains dovish on QE3

What the market is perpetually concerned with is what implications this firmer data has on the future of the Fed’s QE3 programme. Judging by Bernanke’s recent semi-annual testimony before the US House of Representatives, a move to taper QE3 off is not imminent. However, there remains significant support from within the Fed to do so and we expect that as the US recovery continues and uncertainty surrounding US fiscal policy fades, QE3 can begin to be wound down in the second half of this year. If so, this will be very good news for the dollar.

A reversal of the EUR/USD pair’s Q4 2012 rally has been a major weight on the GBP/USD, as was always likely. We expect the euro to lose further ground below $1.30 against the greenback, which should contribute to further pressure on GBP/USD in the coming weeks. There is scope for a bounce back up to the $1.5150 area but really we are expecting to see a sustained move below the $1.50 benchmark in the next few weeks. 

Richard Driver

Currency Analyst 

Caxton FX

Caxton FX Weekly Round-Up: Italy shocks markets

Italian elections ease the heat off the pound for now
Italy has really dropped a bomb on the financial markets with the results of its parliamentary elections this week. No party secured an overall majority.  Centre –left pre-election favourite Bersani secured a majority in the lower house but things are a lot messier in the Senate, where Berlusconi secured enough seats for a blocking minority.

Market tensions are bound to rise; Monti – the man who has delivered significant economic reforms and calmed market fears since he took over at the end of 2011 – received only 10% of the votes, while anti-austerity leader  Berlusconi took almost 30% of the vote.

All eyes are now on the coalition-building process and how Italian bond yields respond. Benchmark 10-year Italian bond yields have risen by almost 9.0% today. The key concern in the financial markets is that Italy can form a government which sticks to its reform programme. It remains to be seen whether or not Bersani can conjure a coalition but market sentiment towards the Italian political situation is likely to remain shaky for weeks to come.

Moody’s finally downgrades the UK’s credit rating
Friday night brought the long-awaited loss of the UK’s AAA credit rating. The move was so well sign-posted that it can’t have caught any market players as a genuine surprise, though it still gave them an excuse to punish the pound further. Fortunately for GBP, the Italian election results have understandably stolen focus.

Looking ahead, the UK PMIs are coming up in the next week; Friday’s manufacturing gauge is expected to pick up slightly on Friday, while no change is expected within the second estimate of UK GDP in Q4 2012.

MPC policymaker Paul Tucker revealed today that no one in the committee thinks that quantitative easing has reached the end of the road, confirming that more can be expected later this year. Sentiment towards the pound remains very weak and it will likely take further panic headlines out of the eurozone for GBP to build on this week’s gains.

Bernanke remains dovish but dollar still rises
Bernanke’s speech today has confirmed that he still lies on the distinctly dovish side of the debate within the US Federal Reserve. The Fed Chairman stressed the benefits of quantitative easing and the costs of high unemployment. This suggests more evidence of momentum in the US recovery will be necessary before Bernanke begins to taper off QE3.

The safe-haven US dollar, along with the yen and Swiss franc, has been a key beneficiary of the tensions coming out of Italy. Firmer US data has also been supportive of the greenback, with consumer confidence and home sales figures coming in well above expectations.

End of week forecast

GBP / EUR	1.1550
GBP / USD	1.5025
EUR / USD	1.3000
GBP / AUD	1.4775

Sterling is trading at €1.16 today and while there is a significant chance of a further bounce up to the €1.18 level, on balance we expect this pair’s downward bias will take hold once again. In terms of GBP/USD, we are predictably comfortable with targeting lower levels.  A move closer to $1.50 is likely before the next mini bounce. Meanwhile we are expecting lower levels in the EUR/USD pair, which currently trades at $1.3050.

Richard Driver
Currency Analyst
Caxton FX

BoE edges towards QE, Fed edges away, while the eurozone remains firmly in recession

We have to hold our hands up and admit that we were caught well and truly offside with respect yesterday’s MPC minutes. We did not even fully expect David Miles to continue voting for QE but not only did he stand firm, he recruited to additional doves to his cause in the shape of Paul Fisher and (more significantly) Sir Mervyn King. With the merits of an interest rate cut also carefully discussed, it was no surprise to see sterling take a beating as a result. We have to now change our position on the BoE’s monetary policy outlook and expect an additional top-up of QE around May time. Not good news for sterling, which continues to suffer from weak growth and the high probability of a UK debt downgrade.

By contrast, the minutes from the US Federal Reserve’s recent meeting gave a real boost to the US dollar last night. They revealed that Bernanke & Co are assessing when and how to scale back their QE3 operations, which was a major driver of dollar-weakness in the last few months of 2012. There have been hints that substantial improvements to the US unemployment rate would be needed before QE3 was wound down but the minutes revealed there was some support for doing so before such improvements are seen. It goes without saying that there remains majority support for maintaining QE3 as it is until greater progress is made with the US recovery and no change to this looks particularly imminent. However, the discussion and the divergence of views within the Fed could lead to a tapering off of QE3 later on in the year. This is why the dollar has rallied.

From the eurozone, we have had yet more weak growth data. A German economic sentiment survey was excellent earlier on in the week but this morning’s PMI figures pointed to a slowdown in the powerhouse economy this month. The German manufacturing sector remained in growth territory by only the smallest margin. Meanwhile, French figures pointed to a sharp dip further into contraction, against expectations of stabilisation. The same is true for the eurozone as a whole, which is set to contract again this quarter.  This is being reflected in a weaker euro today, though GBP remains very vulnerable. 

Richard Driver
Currency Analyst
Caxton FX

Caxton FX Weekly Round-up and Outlook

Weak UK data puts further downward pressure on the pound

The prospects for a strong return to growth for the UK retail sector in January seemed very reasonable based on anecdotal evidence but Friday’s -0.6% stopped us dead in our tracks. When you combine this with the Bank of England’s Quarterly Inflation Report, which highlighted an outlook of weak growth and persistently high inflation over the next few years, it is little wonder that sterling has failed to bounce back in the past few sessions.

The MPC minutes are released on Wednesday and despite poor economic figures, we believe it is more likely that the lone QE voter David Miles dropped his vote than actually recruiting other members to his cause. The high inflation outlook really doesn’t seem consistent with additional QE, particularly while the Funding for Lending Scheme is providing the UK economy with support. Whilst Sir Mervyn King did state last week that the MPC stands ready to do more QE if necessary, we still believe his doubts over how much more this can achieve will dominate the voting in the coming months.

What hasn’t been helpful to the pound today have been Martin Weale’s weekend comments supporting a weaker pound to aid exports and address the UK’s current account deficit. Some might have interpreted this as a rare foray into the dangerous field of verbal intervention but we doubt it was much more than an example of wishful thinking.

Euro gets away with awful eurozone GDP figures

GDP data from throughout the eurozone, which significantly included Germany, was very disappointing last week. The euro is trading at a three-week low against the US dollar as a result of this confirmation that the eurozone recession is worse than many had feared, but levels above $1.33 are still pretty firm. Meanwhile, the euro continues to bully the pound down below €1.16.  

News out of the eurozone may have been bad last week but hopes are rather higher for this week’s eurozone data. Further improvements are expected within this week’s key German economic sentiment and business climate gauges. Meanwhile, Thursday’s eurozone PMI figures are expected to point to stabilization, even if the region does remain in recession territory.

US dollar enjoying plenty of demand amid firmer data

Recent headlines out of the US have been upbeat; weekly unemployment claims data improved sharply, while manufacturing and consumer sentiment figures also impressed. This provided a timely contrast with awful data out of the UK and the eurozone and may well have reminded many players why the USD should, in our view, be preferred to the EUR and GBP (in spite of QE3). The week ahead brings the minutes from the last Fed meeting (Wednesday), which could well reveal some discussion as to when QE3 can start to be scaled back. The bar remains pretty high in respect to this but discussion alone should be USD-positive.

End of week forecast

GBP / EUR	1.1500
GBP / USD	1.5400
EUR / USD	1.3400
GBP / AUD	1.5100

Sterling is trading below €1.16 this afternoon and we suspect the rate will head lower from here, with levels close to €1.15 representing a realistic target. It continues to prove tricky to call a bottom on GBP/USD’s slide but we think the pair will take a close look at $1.54 before a bounce is in sight.

Richard Driver
Currency Analyst
Caxton FX

Eurozone growth data comes back to haunt the euro

Data this morning has confirmed that the eurozone remains very much in recession. We knew that this was the case, but we didn’t know quite conditions were quite this bad. In the final three months of 2012, the French economy contracted by 0.3%, Germany’s by 0.6% and Italy’s by 0.9%, with all three GDP figures coming in worse than market expectations. The euro weakened on all of these data releases. Perhaps surprisingly, given that the market had the above figures already out in the open, the euro also weakened as a result of the overall eurozone GDP figure, which revealed a 0.6% contraction. Meanwhile, Portugal also posted a 1.8% contraction, while the Netherlands shrank by 0.2%. Spain we know contracted by 0.7%. Suddenly the UK’s Q4 GDP figure of -0.3% doesn't seem quite so disastrous. 

The market has been content to ignore weak eurozone data in recent months and as a result the euro has had an easy ride. Super Mario (Draghi) said he would do whatever it takes to keep the euro afloat, Greece managed to kick the can further down the road, and bond yields have been brought under control. All is well? All is not well - these eurozone figures are a reality check and really bring home what the market has seemingly been willing to sweep under the carpet. 

Perhaps the market is not ignoring it and perhaps they are looking beyond at a recovery in 2014, basking in the relief that the debt crisis no longer threatens the very existence of the euro. Either way, if data like today's continues to filter through in 2013 without significant improvement, then the ECB will be forced to act by cutting interest rates and you can be sure that the market will sit up and take notice when that happens. Germany has posted some encouraging figures so far in 2013 but it is anything but plain sailing for the euro from here.

The strong eurozone exchange rate over the past few months will surely have contributed to these awful eurozone GDP figures. The ECB remains reluctant to intervene to weaken the euro but they will have limits to what sorts of levels they are willing to tolerate. This is a key factor behind EUR/USD’s stalling ahead of $1.40. Next up, the Italian elections - expect the nerves to continue jangling over the next week or so. 

Richard Driver

Currency Analyst

Caxton FX