Weekly round-up: Euro ends the week on the back foot

UK inflation prolongs sterling’s weakness

Hopes for a near-term BoE interest rate rise were dashed last Tuesday as UK headline inflation surprisingly eased from 4.4% to 4.0%. The unexpected drop has releived the pressure on the MPC to tighten monetary policy to combat inflation levels that are still double the BoE’s target. Whilst enjoying a minor resurgence at the end of last week, sterling remains broadly out of favour with expectations of a BoE rate rise now pushed back from August to October. A couple of weeks ago, many major players were betting on a May rate rise!

This contrasts with expectations for a further eurozone rate rise in July, following a steady flow of hawkish ECB rhetoric. Meanwhile, the US Federal Reserve remains well behind the curve in terms of interest rate hikes, which along with the ongoing ‘QEII’ programme, is almost wholly responsible for the US dollar’s continuing weakness. The dollar is the weakest currency out there after the yen, nobody wants to hold it. Last week’s poor data from the US labour market, the Fed’s most pressing concern, did little to improve the dollar’s long-term prospects.

Euro still strong but struggling for further momentum

Towards the end of last week, the euro failed to extend gains as peripheral debt issues finally started to weigh. Uncertainty has sprung up around a possible Greek debt restructuring to follow Portugal’s recent bailout request, and Ireland’s credit rating has come under further scrutiny. Nonetheless, the ECB’s interest rate stance, which continues to trump eurozone debt issues, is still likely to provide some scope for further euro upside during the week ahead.

Our expectation is that the single currency may continue to creep higher against the US dollar, but sustaining a level above $1.45 looks overstretched. This strength should also keep the pound trading comfortably above $1.60 against the ailing greenback, but again a push beyond resistance at $1.64 looks unlikely in the short term. Particularly as the markets quieten down ahead of the Easter Holiday period this weekend, we expect a period of sideways trading with investors unlikely to extend riskier positions. Investors are lazy like that.

UK recovery remains patchy

Last week’s UK economic data did show slight improvements in consumer confidence as well as the labour market. However, this was insufficient to improve sentiment towards sterling to any significant degree, particularly as retail sales and average earnings were negative. With such characteristically mixed UK figures, the MPC is highly likely to continue to wait for signs that British growth is on a steadier course before hitting the UK’s struggling economy with an interest rate hike.

Looking ahead to this week, the MPC minutes will put sterling back in focus on Wednesday. If a fourth vote in favour of tightening policy is revealed, this will surely provide the basis for a sterling rebound. Such a change in the voting pattern remains unlikely however, and any sterling gains are likely to be the result of dollar and euro negativity. UK monthly retail sales are also released on Thursday; if last month’s contraction is repeated then we may well see sterling stooping lower across the board. Next Wednesday’s (27th) first quarter UK GDP is the major figure on the horizon, anything less than steady growth is likely to keep sterling pegged on the back foot in coming weeks.

Richard Driver
Analyst – Caxton FX


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Greek debt returns to the spotlight

German minister Wolfgang Schauble today expressed concerns that Greece may be unable to meet its debt repayments by June. This triggered a wave of uncertainty within the debt and currency markets, as fears remerge that Greece may be forced into restructuring its debt.

ECB policymaker Bini Smaghi has also joined the discussion. Smaghi stated that a restructuring of Greek debt would be disastrous for its economy - he, pointed to the risks to its banking sector, social cohesion and even democracy within the troubled state. Greek government bonds have come under real pressure today as a result. Smaghi warned that public speculation over eurozone debt issues can turn out to be self-fulfilling prophecies (almost certainly true of both the Irish and Portuguese bailouts), and so might be the case here. Smaghi went on to assert that if Greek banks were to lose access to ECB financing, then “The Greek economy would be on its knees”, which seems somewhat hypocritical to me...

Last week saw Portugal request a bailout - the market remained broadly unconcerned, perhaps relieved that the issue had finally been addressed. The real concerns were that Spanish and Italian debt would come under pressure as investors focused elsewhere, but these struggling states have impressively been able to maintain investor confidence thus far.

Greek officials have denied the need to restructure their debt; but then again Portugal strongly rebuffed accusations that they would require a bailout (and we all know how that ended). The current picture of Greece’s economy is one of GDP contraction, low tax revenues, soaring unemployment and vicious public sector cuts. Prevailing arguments suggest that this is creating a downward spiral from which the state cannot pull out - unless its debts are written off.

The euro has come under real pressure as a result of the various comments that have surfaced today, dropping by over a cent against the dollar. Could this finally be the turnaround in the euro we’ve been waiting for? It seems unlikely. We’ll have to wait and see how the Greek situation develops, but today’s euro-weakening should only be a temporary. We have seen time and again the resolve of Asian sovereigns to buy the euro, particularly when it has dipped in the European session.

In addition, we’re already seeing the euro recover as we speak, suggesting that market concerns may have been overdone. Nonetheless, this has been a welcome break for a struggling UK currency, which is now trading at a more palatable level above €1.13.

Richard Driver
Currency Analyst – Caxton FX
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Is the rally in commodity prices coming to an end?

In October last year, Brent crude oil was trading at around $80 per barrel. In January this year, it was trading just below $100, and on Monday of this week, it exceeded $126 per barrel, a high not seen since early 2008. However, in the past two days we have seen the price drop by $5 per barrel, and the price of gold has also dropped significantly. This begs the question –has the rally in commodity prices (as driven by oil prices) run out of steam?

The trigger for the recent sharp decline in oil prices on Tuesday can be attributed to Goldman Sach’s, who earlier suggested that investors should take profits after the International Monetary Fund voiced concerns that higher energy prices could hinder the global economic recovery. Speculators quickly jumped on Goldman’s advice; accentuating the price decline and making clear that the drop was the result of an independent intervention from a major market player rather than a natural slide.

So what’s the outlook for oil prices? Well, based on the International Monetary Fund’s downgraded economic growth estimates for the US and for Japan (two of the world’s largest three economies), demand for oil looks set to decline. However, geo-political tensions in the Middle-East are constraining the supply side and OPEC recently announced that Saudi Arabia is unable to increase output to cover the decrease in Libyan output.

In a recent blog on the Wall Street Journal Digital Network, a strong argument indicating that June could be a point at which commodity prices come off their peaks. In November 2008, Brent crude was trading under $50 per barrel, since then it has been on a steady uptrend. What triggered this rally? The Federal Reserve’s quantitative easing programme. – which is set to draw to a close in June; potentially cutting short the supply of funds currently directed into oil futures.

How might this affect the currency markets? Oil producing states such as Canada, Russia, Norway, and other commodity-linked economies such as Australia are currently benefitting from greater profits on their exports. This has been a major factor in the strong performance of their currencies in recent months. If oil prices continue to show signs of topping out, it may trigger investors to take profit on considerable gains made on riskier currencies.

Richard Driver
Currency Analyst – Caxton FX
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Sterling takes a pasting as UK inflation undershoots

What’s driving the currency markets more than anything else at present? Central Bank interest rate policy. What’s driving interest rate policy more than anything else? Inflation levels.

For this reason, you can see why the market response to today’s UK headline inflation figure for March has been so marked.

Data revealed that inflation in the UK has dropped from 4.4% to 4.0% the first monthly decline since July 2010 and the largest decline since February of that year. With oil prices (as well as other commodities) through the roof, we must admit we were expecting another rise, albeit a modest one. The figure is certainly welcome news to consumers and indeed the Bank of England (BoE), but it hasn’t done sterling any favours.

A fall in food and drink prices appears responsible for the monthly inflation drop. It certainly plays into the hands of Mervyn King and Adam Posen; they have for a long time claimed that inflationary pressures were temporary and today’s data supports this view.

Sterling suffered in the immediate aftermath of the news, falling sharply against the euro and the US dollar as investors scale back their BoE interest rate expectations. A May interest rate hike is now highly unlikely, and the current market consensus of an August rate rise seems altogether more probable. With inflationary pressures potentially easing, the MPC can sit tight and wait for the UK recovery to gain traction before shifting policy.

With UK economic figures still very inconsistent, evidenced this morning by poor retail sales, we now expect sterling to underperform for the remainder of this month. Sterling is looking decidedly vulnerable against the euro in particular, as the market has fully priced in another two ECB rate rises this year. These expectations may to some degree be dependent on eurozone inflation figures due to be released on Friday. With today’s UK data in mind, only a similarly sharp dip in eurozone inflation is likely to limit the single currency’s appeal.

Whilst arch MPC-hawk Andrew Sentance may well be fuming at today’s figures, the UK doves needn’t get ahead of themselves. UK inflation remains double the BoE’s target and if we see a strong UK growth figure for the opening three months of 2011, then a second quarter UK rate rise could return to view. In the near term, next week’s MPC minutes will interest the markets. However, a turnaround in sterling’s fortunes may well have to wait until the key GDP figure at the end of the month.

Based on today’s unforeseen inflation figures, we have put our BoE interest rate expectations back in line with the market at August, pending the GDP figure.

Richard Driver
Analyst – Caxton FX


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UK inflation due tomorrow: strong surge necessary to convince market of a May rate rise.

Monthly UK headline inflation figures are released tomorrow. Another sharp increase in consumer prices is likely to heighten pressure on the Monetary Policy Committee (MPC) to replicate last week’s European Central Bank rate rise decision. The market’s forecast suggest that last month’s rate of 4.4% will be maintained but with commodity prices regularly hitting record highs, we find it hard to believe that UK inflation levels for March will not have increased, if only by 0.1% or 0.2% m/m.

Sterling is likely to benefit in the near-term from any rise in UK inflation as speculators set their sights on a Bank of England rate rise at next month’s meeting. Considering the extra stress that higher prices put on consumers, it might be surprising that sterling would benefit from higher inflation. But with Central Bank interest rate policy continuing to dominate major currency trends, economic fundamentals are have become of less importance from the market’s perspective. That said, the market is somewhat more responsive to positive UK economic data than to most other economies, because the MPC has made it clear that it’s loathe to raise interest rates until UK growth shows a firm foothold. The most reliable evidence for this growth will come when first quarter GDP is announced at the end of this month.

The MPC has given indications that 5.0% UK inflation could be a benchmark which may finally force its hand with regard to a rate hike. Bearing in mind current levels, expectations of a May rate rise could therefore be over-optimistic. It would take quite a significant jump to reach the 5% benchmark this month so we believe the MPC will be willing to continue to delay tightening policy.

The market currently has a 0.25% UK interest rate rise fully priced in for August. We are still set on June.
This is how we see tomorrow’s inflation figures effecting BoE rate rise expectations...

Inflation remains unchanged at 4.4%: August – probable July/June – possible May - highly unlikely.

Inflation rises to 4.5-4.6%: August – possible June – probable May - unlikely.

Inflation rises to 4.7% or above: August – highly unlikely June – probable May - possible.

In terms of sterling’s near term outlook – ie next few days – sterling should receive a boost if a number above 4.4% is recorded. However, the effects are likely to wear off by the end of the week with the strength of the single currency showing no signs of diminishing.

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

Japan’s earthquakes (Kobe 1994 and Tohoku 2011): the effect on yen

One month on from the Japanese natural disaster on March 11th, we saw this as an interesting opportunity to compare the currency market’s response with the earthquake that struck back in 1994.

On January 17th 1994, a 7.3 magnitude earthquake hit Kobe; killing over six thousand people and causing ten trillion yen worth of damage (amounting to roughly 2.5% of Japanese GDP). The yen proceeded to strengthen by 18% against the US dollar in the space of three months, before almost halving in value in the subsequent three years.

So how does this compare to yen’s response to this most recent disaster?

The Japanese currency did appreciate, but only by 5% against the greenback and in the space of just 5 days. This climb was reversed within the following five days as the world’s G7 Central Banks intervened to curb further yen appreciation. Since that date the yen has continued to steadily lose value as the market picks up on the lower growth potential and the expectation of rock bottom interest rates in Japan for some time to come. Indeed the yen is currently down at a 7-month low with further room to drop.

The natural market response (yen investment) in the wake of last month’s earthquake was cut well short by the unprecedented and prompt Central Bank intervention. In the current climate, the Bank of Japan is simply unwilling to allow its already weak economy to suffer the serious knock to its exports that a stronger yen would amount to. Obviously we are yet to find out whether the yen will devalue to the same extent as in the late 1990s, but the current forecast is for continued depreciation on the basis of weak fundamentals.

The USD/JPY rate currently sits at 85 yen. Forecasts 12 months out expect to see the US dollar reach 100, but the 144 level reached in 1998 does at this point seem very far-fetched, particularly as the Fed are hardly in a hurry to tighten monetary policy either.

Richard Driver
Analyst – Caxton FX


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BoE sticks, ECB twists.

Today it was announced that the BoE left the interest rate unchanged at 0.5%, whilst the ECB announced a quarter percent rate rise to put the eurozone base rate at 1.25%. Given that these decisions were widely predicted, the market response to the news has been somewhat muted.

The ECB press conference was of more interest. Trichet’s comments may not have triggered any significant movements but we do think they could have signalled an end to the euro uptrend that we have seen over the past month. Trichet refused to commit to a further rate rise, adopting a wait-and-see approach. If anything his comments suggested that the rate rise was more at the “once-and-done” end of the spectrum than, the “first-of-several” end.

Significantly, Trichet omitted the phrase “strong vigilance” with regard to monitoring inflation levels, reflective of a less ECB hawkish stance. He certainly reiterated that price pressures would be closely watched, but there’s reason for uncertainty surrounding ECB monetary policy going forward, which contrasts with broad expectations that the BoE will hike rates at least by July.

As well as a broadly euro-negative ECB press conference, the single currency has also come under some pressure today in light of last night’s Portuguese bailout request. Talk of the markets turning their attention on to Spanish debt issues has created a renewed air of uncertainty around the eurozone’s fiscal problems. We have held the view over recent weeks that the euro is overvalued and today’s announcements appear to have given further credence to this view.

In other news, Japan’s misery continues as another earthquake strikes the northeast of the country. It’s fortunately not on the same scale as last month’s quake so we can be hopeful that there’ll be considerably less devastation caused. Global stocks have fallen on the news but the currency markets remain as yet unpeturbed.
Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Why the euro has reached its heights...

Today we saw the euro hit a fourteen month high against the dollar, breaking stubborn resistance to currently trade above $1.43. We have subsequently seen euro/US dollar forecasts of $1.40, $1.45, $1.50 and beyond amid expectations of an ECB rate tightening cycle.

Despite such forecasts, we hold firm to our view that the euro is overvalued at $1.43 and will run out of momentum fairly soon after tomorrow’s rate rise, assuming that Trichet only announces a 0.25% rate rise and not a 0.5%. We are confident that a 0.5% is too hawkish even for the ECB.

So what are the dollar’s long-term prospects? A much-improved picture of the US economy has emerged from the US, to the extent that we can be quite confident that QEII will not be extended past June. A 2011 Fed interest rate rise has even been mooted by one or two US policymakers; such are the prospects for US growth looking forward. In conclusion, the dollar’s weakness seen in recent weeks is unlikely to last past this summer, as the market prices in a more hawkish Fed stance.

The UK has also enjoyed an improved economic outlook on the back of very strong services data on Tuesday. Some hopes for a May rate rise may have been dashed by today’s release of disappointing manufacturing and industrial data for February but it really didn’t tell us anything we weren’t already aware of. Regardless of today’s figures, expectations of a June rate rise have been strengthened over the past week, which is likely to place the BoE at the front of the queue (a factor that is bound to be sterling positive) following tomorrow’s ECB decision.

Added to a more optimistic view of the euro’s major counterparts, we expect eurozone problems (and indeed the impact of tomorrow’s ECB rate rise in exacerbating those problems), to come under the spotlight in coming weeks. Portuguese bond yields are at 9% and look set to reach new record highs up near 10%, causing many to change their bailout timeframe from a matter of months to weeks. Though we have said this for some time, the cost of their debt really isn’t sustainable and this rate rise could be the straw that breaks the camel’s back as far as Portugal is concerned. In addition, details of a more permanent eurozone-wide bailout facility remain elusive, which has irritated markets in the past and those frustrations could yet return.

Whilst we do think that the euro will drop off from its current highs, we do not think that the single currency will fall too far below the psychological $1.40 mark. We are confident that Asian investment will keep the euro well-supported, that the market has grown a thicker skin to peripheral debt issues, and that a certain degree of bailout crisis has already been priced into the euro. Nonetheless, $1.43 for euro/US dollar at the end of this month would certainly be a surprise.

Richard Driver
Analyst – Caxton FX


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UK services sector shows impressive growth- has faith in the UK recovery been restored?

UK services sector figures were released this morning, showing a level of expansion not seen for thirteen months. In combination with strong construction data yesterday, this paints a much improved picture of the UK economy. It’s certainly a more positive picture than has been seen over the past few weeks following disappointing consumer confidence and retail sales data. Sterling has enjoyed a real boost on the back of the figures, climbing by 0.8% against the dollar, and over a 1% against the euro.

So how will this affect sentiment towards the UK economic recovery going forward? Well, it’s no secret that our economy is heavily geared towards the services sector (something the Conservative government are trying to amend but for the time being holds true). So the solid growth levels we have seen over the past three months in the services sector are broadly indicative of a decent GDP figure for the first quarter.

Current estimates for the April 27th first quarter GDP announcement are back up around 0.8% in light of today’s data. This matches the quarterly growth figure that we saw last summer, which was then followed by a 0.5% contraction in the final quarter of last year. It would perhaps therefore be premature to assume the UK’s recovery is guaranteed. However, the signs are certainly improving and, predictably, the debate surrounding when the BoE will raise interest rates has recommenced.

Over recent weeks, an August rate rise has been the dominant expectation. However, the brighter outlook for the economy indicated by data in the past couple of session has strengthened our case for a June rate rise. We still believe, along with 66 out of a survey of 67 economists, that a rate rise in Thursday’s BoE announcement is highly unlikely. We also believe that May will come too soon even if first quarter GDP comes in above forecast as the MPC will want evidence that the recovery can be sustained.

So what has today’s data done to our longer-term sterling outlook?

Major gains against the US dollar are still set to be limited by what we expect to be a slightly weaker euro over the coming weeks (the strength of sterling/US dollar has a close correlation with that of the euro/US dollar pairing). Nonetheless, we can see the pound hitting $1.6350 by the end of April, and climbing to €1.1650 against the euro.

These forecasts may be a little too sterling-positive for some. Sceptics towards the UK economy will require evidence of a more consumer-led recovery before investing in the pound, which in light of ongoing public spending cuts may be some time away. However, we believe specualtion of a second quarter BoE rate rise will provide enough fuel for some decent sterling gains.
Richard Driver
Analyst – Caxton FX


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The Aussie, the Kiwi and the Loonie- will the good old days of two or three to the pound return?

GBP/AUD: 1.56

GBP/NZD: 2.10

GBP/CAD: 1.56

These are the current interbank rates for sterling against the aussie, the kiwi and the loonie (Canadian dollar). Four years ago, one pound would buy you two and half aussie dollars, almost three kiwi dollars, and well over two Canadian dollars. These levels are reflective of historically riskier currencies versus the size and safety of the UK economy in years gone by. So, will we see these sorts of levels again or must be consigned to a new trading range?

In the case of the export-driven Australian and New Zealand economies, these have benefitted on a huge scale from the rise of China. Now the world’s second largest economy, China is a major trading partner to these two antipodean nations, and with commodity prices so high, their currencies have appreciated strongly. The higher interest rates of these two economies has for the past few years also provided investors with a far higher yield than those available in the UK, the US or Japan for example. This interest rate differential is set to be maintained for at least the next couple of years to come. The global recession hit the UK far harder than either Australia or New Zealand and it will take some time yet before a full recovery is established and it cope with fully normalised monetary policy (ie higher interest rates).

The loonie has also had reason to perform well, though for different reasons. Canada’s economy has benefitted from a broad rise in oil prices and from improving conditions in the US economy, its main trading partner. Canada’s economic fundamentals are solid – far more so than the UK’s - and the loonie had appreciated against the pound despite having equally low central bank interest rates.

None of the factors that have caused these ‘growth-linked’ currencies to appreciate against the pound, particularly the strength of the world’s two largest economies, look likely to fade any time soon. It would therefore be of huge surprise even in the long term to see a return of the levels of four years ago. The outlook for the British economy, in comparison to the “riskier” ones discussed above, looks distinctly pessimistic. With UK suffering economic contraction in the last quarter of 2010 and continuing to struggle with persistently high inflation, it might be argued that sterling is presently a riskier currency than the aussie dollar on a fundamental level. The day the pound has fully regained, for instance the near 40% it has lost against the aussie in the past 4 years, looks a very long way off indeed.

Although we actually view sterling to be undervalued at present (many others do not), it certainly appears that the current lowly trading ranges are set to continue for some time.

Richard Driver
Analyst – Caxton FX


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