Caxton FX Weekly Round-Up: GBP, EUR, USD

Standard and Poor's cuts Spanish credit rating but Rajoy still delaying 

Rating agency Standard and Poor’s cut Spain’s credit rating by another two notches last week, which puts the country’s debt only one notch above ‘junk’ status. Moody’s already has Spain at this level but when it publishes its report in a fortnight, the market response could be very negative indeed if it does in fact downgrade Spain to junk territory. Speculation that Standard and Poor's axe wielding would prompt an aid request from Spain intensified last week but the latest reports suggest that not only will Rajoy wait until after regional elections on October 21 but he will wait until November before officially requesting a bailout. More delay then, though at least we have an idea of timescales.

Interestingly though, Spain’s bailout looks set to become part of a larger package containing a bailout for Cyprus and an amended loan package for Greece. This will relieve EU officials of the requirement to repeatedly obtain approval from the eurozone’s national parliaments. In terms of the eurozone’s other key problem child, a Greek deal on a new austerity package is likely to be agreed in time for this week’s EU Summit, which should help to set market nerves at rest with respect to the next tranche of Greek aid.

In terms of eurozone data this week ,we have a key German economic sentiment gauge released on Tuesday, which looks likely to improve slightly, though probably not enough to trigger any rally for the euro.

Big week of UK announcements ahead 

Last week brought a lull in terms of UK news. We learnt UK manufacturing production underperformed in August and that the UK trade deficit widened quite dramatically, but the week ahead brings plenty of key domestic figures. UK inflation is set to take another sharp downturn, which could well embolden the more dovish members of the MPC to vote for more QE next month. The minutes from the last MPC meeting are also released on Wednesday, which may be slightly more downbeat based on September’s weak PMI growth figures. This could potentially hurt the pound if it is enough to convince investors that a few members will be swayed to vote for more QE in November.

UK labour data looks set to be solid again on Wednesday, while we should also see some better growth from the UK retail sector. The market will watch all these figures closely but one eye will be kept on next week’s (October 25) initial Q3 UK GDP estimate. This is the next major event for sterling this month.

We are expecting plenty of range-bound trading this week, with EU leaders set to put off major announcements until next month. Having failed once again ahead of $1.61, GBP/USD looks set to return to the $1.60 level. We are sticking to our guns in terms of our predictions that when this pair does finally make a sustained break away from the $1.60 level, it will be to the downside. The euro continues to look tired as it approaches the $1.30 level and a dip below $1.29 looks possible this week.

Sterling is struggling to sustain any significant gains against the euro. We expect the €1.2350 will provide plenty of support in the sessions to come, so we’d view current levels to strong ones at which to sell the euro. A break higher back up towards €1.26 isn’t out of the question this month.

End of week forecast
GBP / EUR 1.2450
GBP / USD 1.5975
EUR / USD 1.2850
GBP / AUD 1.5800

Richard Driver
Currency Analyst
Caxton FX

What the fiscal cliff could mean for the US and global economy

With the US fiscal cliff less than three months away, the International Monetary Fund has chimed in this week with its concerns for both the US and the global economy as a whole. The US is edging towards an enormous fiscal tightening the like of which we haven’t seen since 1947. The nerves, pressure and speculation surrounding the issue will only going to intensify as US politicians argue and stall their way through the final quarter of the year.

The IMF has estimated that if a deal isn’t reached to avoid a full-blown fiscal cliff, then the US could well plunge into recession next year. The organisation estimates that the US economy will grow by 2.1% in 2013, while the impact of the fiscal cliff would weigh on GDP by 2.2%.

While the fiscal cliff does not appear to threaten a global recession next year, it would certainly have a significant impact; rating agency Fitch has estimated that it would cut global growth in half. As far as eurozone growth is concerned, developments from within the region could easily tip the IMF’s 2013 eurozone GDP forecast of 0.2% well and truly into recession territory regardless of the fiscal cliff. However, the organisation sees the failure to reach a compromise on the fiscal cliff knocking 0.4% off growth, which would seal the deal regardless.

If an agreement between the Republican controlled Congress and Democrat controlled Senate, it is highly unlikely that the payroll tax cut will be extended - there appears to be consensus on this issue. The expiration of this tax cut then will likely shave 1.0% off US GDP, which is nearly half the amount that the IMF is estimating of a full-blown fiscal cliff. This would leave global growth down around 2.6% in 2013, instead of the 3.6% the IMF is anticipating on the assumption a deal is reached. Unless US politicians pull a rabbit out of their collective hat, the fiscal cliff issue is likely to end in pain for all concerned, just how much pain is the real question.

Richard Driver

Currency Analyst

Caxton FX 

GBP/USD Outlook for Q4

US growth data pointed to a marked slowdown in Q3, which prompted the US Federal Reserve to finally deliver the long-awaited QE3 in mid-September. This has helped to keep the dollar on the back foot for much of the last month. The prospect of another round of QE to boost the world’s largest economy allowed US and European equities to maintain their summer momentum, never an environment conducive to dollar-strength.

The ECB’s pledge to purchase unlimited quantities of distressed debt (particularly Spain’s) and the Germany Constitutional Court’s approval of the European Stability Mechanism, which has been launched this week, also eased market worries and weakened demand for the safe-haven US dollar. This all coincided with a solid upturn in UK data; growth in August particularly picked up around the Olympics and GDP data for Q2 was revised up to an improved -0.4%.

However, some poor UK growth figures in the past week from the manufacturing and services sector in particular have taken the edge off the GBP/USD rate. Investors are once again stepping up their bets that the BoE will decide in favour of further QE in its closely watched November meeting. Much will depend on the initial UK GDP for Q3, which is released on October 25. The NIESR’s estimate this week of 0.8% growth may be a little too punchy.

Eurozone frustrations are now creeping into some dollar-strength. Spain is dragging its heels on requesting a bailout, while there remains uncertainty surrounding whether or not Greece will receive its next bailout tranche and whether we will see another Greek debt restructuring. In addition, we have seen plenty of evidence that not only is the eurozone heading into a recession, but that Germany could well be unable to resist this downward spiral. Some distinctly gloomy growth forecasts for the global economy from the IMF have also weighed heavily on market sentiment this week.

The combination of renewed weakness in UK data and renewed eurozone concerns saw the GBP/USD pair top out at $1.63 last month. This level represented a one-year high and GBP/USD’s resounding failure to breach this benchmark has resulted in a fairly sharp decline to $1.60, where it is currently finding support.

We expect the dollar to maintain the ascendancy in the fourth quarter, which should force the GBP/USD rate to make a sustained move below the $1.60 level in the short-term. Beyond this, we see the rate closer to $1.55 by the end of the year. There is plenty on the horizon to be nervous about; the US election and fiscal cliff, Spain (including probable credit rating cuts), Greece and global growth, which should all filter into a stronger US dollar. This baseline scenario of a lower GBP/USD rate relies on a decline in the EUR/USD rate and a continued loss of momentum in global equities, both of which we are sticking to. One major caveat to this positive outlook for the USD is that at some point in the coming weeks, Spain looks likely to bite the bullet and request help, which will likely give the euro a temporary lift and hurt the USD. 

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Market Round-Up: GBP, EUR, USD

US dollar finding its feet at last The US dollar has enjoyed itself in recent sessions, amid returning eurozone frustrations and a surprise drop in the US unemployment rate. Last Friday saw the US jobless rate drop to 7.8%, which is the lowest level seen since January 2009. The labour market report was by no means glowing but it did point to growth, which is a becoming a worryingly absent feature in many major economies. Labour market progress wasn’t the only source of optimism. This month’s US services sector figure was the best seen in six months, while the US manufacturing returned to positive growth territory for the first time in four months. Clearly the US economy faces major headwinds but the absence of further deterioration has helped the dollar to bounce back in the past three weeks or so. Concerns over the eurozone situation have also been a key factor behind the US dollar’s resurgence. PM Rajoy has resisted market pressure to request a bailout and in doing so has failed to reduce the uncertainty that surrounds the situation. On a more positive note, newswires are full of reports that Greece will receive its crucial next tranche of aid in November, though the market remains edgy on speculation of another Greek debt restructuring. Investors are unlikely to welcome more haircuts. The IMF has chimed in with some global growth forecasts this week and the picture does not look pretty. Assessments of Spanish and Italian GDP were bleak with estimates of 1.5% and 2.3% contractions this year. The IMF expects China to avoid a hard-landing, though the slowdown will still be significant, while growth in other BRIC nations provides plenty of reason for investors to be cautious. UK data disappoints but Q3 GDP should provide some optimism This month’s updates from the UK manufacturing, construction and services sector all disappointed, revealing a post-Olympics slump. This wasn’t enough to prompt the BoE into any further emergency easing measures in its October meeting, though bets have since increased on the prospects of more quantitative easing in November. We are still expecting a decent showing from the Q3 UK GDP figure at the end of the month. Indeed a leading think tank has today suggested a 0.8% result on the 25th October. Sterling is trading off its recent lows of €1.2350, which represents 81p in terms of EUR/GBP. Sterling is now trading over half a cent higher and we do see it heading higher within its range in the coming few sessions, provided we don’t see any major headlines of progress from the eurozone. Against the US dollar our outlook for sterling is rather less optimistic. GBP/USD has today lost grip of the $1.60 handle, dipping below this psychological level for the first time in a month. We expect the recent $1.63 high to represent a ceiling, but current levels are still strong as far as buying dollars are concerned. Our year-end forecasts for GBP/USD bring the rate much closer to $1.55. End of week forecast GBP / EUR 1.2450 GBP / USD 1.5900 EUR / USD 1.2770 GBP / AUD 1.5900 Richard Driver Currency Analyst Caxton FX

Sterling struggles as UK growth runs out of steam at end of Q3

After an excellent few weeks in which UK figures repeatedly beat expectations to the upside, this week’s figure reveal that UK growth slowed up in September, which represents a disappointing conclusion to the third quarter. All three of the monthly updates from the UK manufacturing, construction and services sectors came in softer than consensus expectations, which is likely to bring the UK government firmly back down to earth.

The Chief Economist of Markit, the company which compiles the PMI data that we are talking about, has suggested today that UK GDP will only grow by 0.1% in the third quarter, which is well below our and the market’s expectations. Before this week, we were roughly in line with consensus expectations of a GDP showing of 0.6%. Clearly this week’s figures cannot be ignored but a downward revision to 0.1% is a little too drastic for us. We are still anticipating growth close to the 0.5% mark. The August Inflation Report from the BoE, which anticipated growth of as much as 1.0% in Q3, is likely to be well wide of the mark.

Although today’s services data suggests that the steady and impressive improvements we have been seeing in the UK labour market may be coming to an end, the order books are at least looking pretty healthy. Still, the figures do firmly indicate that the strength in the UK economy seen in August was down to temporary Olympics-related demand. Underlying growth appears to be significantly weaker.

Many market players will naturally respond by speculating that the Bank of England will react with another round of QE. Thursday will not produce a QE decision, though November’s BoE meeting is likely garner far more debate from within the MPC. Much will depend on the Q3 preliminary GDP reading at the end of the month.

Richard Driver

Currency Analyst

Caxton FX

October Monthly Outlook: GBP/EUR and GBP/USD

Sterling to benefit from resurgent UK economy

From the eurozone, September’s two key events were ECB President Draghi’s announcement of his long-awaited bond-buying plan and the German Constitutional Court’s decision to approve the permanent bailout fund. Since then, there has been a real lack of any further concrete developments, which has understandably frustrated many market players and caused some risk aversion. As the next major event in the timeline of the eurozone debt crisis, speculation over the imminence of a Spanish bailout request is dominating market thinking at present. PM Rajoy does not actually appear to be much closer to making a formal request; he looks likely to wait until after Spanish regional elections to be held on October 21.

From the US, we have finally seen Ben Bernanke deliver what the market has been waiting for – more support for the US economy in the form of QE3. The move was priced in to a large extent but the dollar has been unable to stage any significant recovery in the immediate aftermath of the Fed’s announcement.

Conditions here in the UK continue to look a little brighter, though understandably many investors will still need further positive evidence to be truly convinced that the economy is on a path to a sustained recovery. However, with the Japanese and US central banks engaging in QE in September and the European Central Bank also taking monetary easing measures of its own (though rather more unconventional), the market is beginning to look more favourably upon the pound again.

GBP/EUR

Spanish delays will hurt the euro

Sterling has made a decent recovery against the euro in recent weeks, after what was quite a sharp decline as a result of the optimism that followed the announcement of the ECB’s bond-buying plan. There has been a positive response to some of the UK figures that have emerged in recent weeks; trade balance data revealed a dramatic rise in exports to destinations outside the EU, suggesting UK businesses are adapting to deteriorating eurozone demand. Meanwhile, UK unemployment figures continue to defy the overall weak picture of UK economic growth by making significant strides. From retail sales data to public sector borrowing figures, the UK economy has been beating market expectations time and again and this is filtering into some sterling strength. Another positive has emerged with the latest upward revision to the UK’s Q2 GDP figure to -0.4%, considerably better than the original estimate of -0.7%. Hopes are high for a very strong showing for the Q3 UK GDP figure released on October 26.

The minutes from the MPC’S September meeting revealed a unanimous vote against further QE (for now). The decision in favour of leaving the BoE 0.5% base rate unchanged was also unanimous. The fact that one MPC policymaker saw a good case for QE in September did not go unnoticed but as things stand, the Bank of England is understandably in wait-and-see mode. In light of the increased room for domestic optimism and the easing of financial conditions in the eurozone in recent weeks, it will not come as much of a surprise to learn that we are not expecting any fresh monetary easing measures from the Bank of England this month. November is likely to see the Bank assess its options much more carefully though.

Coinciding with strong economic figures has been an increased appetite for the pound as a relative safe-haven. Gilt yields have declined in recent sessions as investors attempt to take cover from renewed uncertainties from the eurozone and as usual this has boosted the pound by association. With the QE decisions from the US Federal Reserve and the Bank of Japan in September, sterling has climbed a little higher up many investors’ wish lists in recent weeks.

Putting improved UK conditions to one side, the major factor behind GBP/EUR’s climb in the past month has been a shift in sentiment against the euro, as is predominantly the case when this pair climbs. The market relief that followed the ECB’s commitment to buy unlimited quantities of distressed peripheral debt has well and truly worn off. Investors have refocused on the major issues facing Spain and Greece in particular.

PM Rajoy has thus far snubbed the opportunity to take advantage of the ECB’s offer to purchase Spanish debt, fully aware of the austerity demands that will accompany such intervention. Rajoy is under enormous pressure domestically, with the rich Catalonia region demanding independence and fierce protests taking place in Madrid over existing austerity measures. The market is likely to have to wait until after regional elections held on October 21 for Rajoy to bite the bullet, which leaves a good three weeks of frustration ahead. That said, if rating agency Moody’s cuts Spain’s credit rating to ‘junk’ status, then a spike in Spanish bond yields could force Rajoy’s hand a little sooner.

Greek saga remains volatile

The situation in Greece also remains typically uncertain. October is an important month too, with some chunky bond repayments maturing. Disagreements not only exist between Greece and the Troika (EU, ECB and IMF) but between the IMF and the EU. With the Greek debt profile blown even further off track by a deeper than expected recession, the IMF is now pushing for another Greek debt restructuring in order to get its debt sustainability back on track. Unsurprisingly, more ‘haircuts’ is not at the top of the EU’s list of priorities.

It looks as if there is some consensus over giving Greece an additional two years to meet its targets and the government appears to have been reached an agreement for €13.5bn in additional spending cuts that they hope will unlock the vital next tranche of aid. However, the agreement still needs Troika approval and would need to be approved by the Greek parliament, which amid violent public protests in Athens is no dead cert. Speculation has surrounded the need for a third Greek bailout but this option looks to be a non-starter as it would require parliamentary approval from individual member states. The bottom line is that Greece may well leave the eurozone but EU leaders are unlikely to let this happen while conditions in Spain remain so tense. The pressure for stronger signs of progress will be turned up once again at the next EU Summit on October 18-19.

Sterling has recouped its mid-September losses against the euro and is back trading above the €1.25 level. With market confidence so shaky at present, any concrete progress - most importantly from Spain in the form of a bailout request – will likely give the euro a significant lift. However, our baseline scenario is that this will not occur and that sentiment will continue to weaken towards the euro, helping sterling to build on its domestic economic resurgence and resume its uptrend against the euro.

GBP/USD

Dollar to strengthen despite QE3

The US Federal Reserve finally pulled the trigger on QE3 in September, which meant it was another very soft month for the US dollar. There have been some bright spots amongst US figures in the past month, with trade balance, retail sales and consumer confidence figures all showing some improvements. However, there has been plenty of evidence of continued economic weakness to support Ben Bernanke’s decision to turn the printing presses back on; last month’s key employment update gave little to cheer about. In addition, the final US GDP figure for Q2 was sharply and unexpectedly revised down to 1.3% from 1.7%.

The issues of weak US economic growth and a long period of quantitative easing are by no means at the top of most investors’ list of concerns. The US dollar has strengthened a little in the past fortnight, amid waning euphoria surrounding the QE3 announcement and the ECB’s pledge to purchase peripheral debt. Spain has not asked for a bailout, Greece has not secured its next tranche of aid and growth across the world is slowing. These are all dollar-friendly factors and the slowdowns being seen in China and the eurozone (including Germany) are of particular concern.

Whilst UK growth data has been remarkably positive in recent weeks, the ongoing fragility of the UK recovery has already been highlighted this week by a weaker than expected manufacturing figure. If sterling is to avoid another short-term sell-off against the US dollar, the UK services figure released on October 3 must be firm. However, sterling should get plenty of support in the form of the preliminary Q3 UK GDP figure released on October 26; we are looking for a robust quarterly showing of around +0.6%.

As things stand, sterling is trading almost two cents below September’s 13-month high of $1.63 and we think this high will remain a ceiling for this pair. Regardless of QE3, we see plenty of scope for increased demand for the safe-haven US dollar. We are still anticipating weakness in the EUR/USD pair, which should send GBP/USD back below $1.60 in October. 

Richard Driver

Currency Analyst

Caxton FX

UK Q2 GDP contracts by less than expected: things are looking up

The final UK GDP figure has been announced this morning and the news was very good; the UK economy only contracted by 0.4%, less than than the previous -0.5% estimate and considerably less than the original -0.7% reading. So in simple terms, the UK economy was only around half as bad as first thought in Q2. An upward revision to the construction sector’s performance is a key cause of the upward revision.

The Bank of England reckons that the extra bank holiday for the Queen’s Jubilee in June cost the UK economy as much as 0.5%, so underlying growth could actually have been positive in Q2. There is a big difference between stalling growth and deepening recession. Today’s upward revision really dovetails with what Mervyn King has been saying for the last few months. The figures released by the Office of National Statistics (the GDP figures) have underestimated UK growth, or at least overestimated the impact of the Jubilee bank holiday.

UK figures have been showing some significant improvements this summer, helped by the Olympics, and MPC member Fisher has commented today that we can expect a “very strong” GDP reading for Q3. In fact, we are expecting Q3 growth to more than make up for Q2’s contraction, perhaps showing a reading as high as 0.7%.

Of course, downside risks should be noted and the UK is a long way from being out of the woods and free from recession fears. The eurozone debt crisis continues to pose a threat to our banking system and it is certain that eurozone growth will be more or less non-existent next year. Nonetheless, this morning’s figure is good news and October 26 will bring more in the form of a robust preliminary Q3 GDP reading. All good news for the pound, which has already enjoyed a rally today, trading above €1.26 and $1.62. 

Richard Driver

Currency Analyst

Caxton FX

Will the ECB cut interest rates next week?

Away from what’s going on in Spain and Greece, let’s take a look ahead at next week’s ECB meeting. This week’s key German business climate figure was awful and the significance of this will certainly not have been lost on the ECB. With economic contraction throughout the periphery weighing on growth in the eurozone’s powerhouse economy – will the ECB finally put its deeply engrained fear of high inflation to one side and give Germany and perhaps more importantly the rest of the eurozone a helping hand by lowering interest rates?

A German contraction in Q3 is not a certainty but it is now looking likely, particularly in light of the latest German confidence figure, which hit its lowest reading since March 2010. Spain’s central bank warned yesterday that its economy’s GDP continued falling at a “significant rate” in Q3, while S&P forecasted that Spanish GDP will contract by another 1.4% in 2013 and the eurozone economy a whole will achieve zero growth. With conditions so dire in Germany’s major eurozone trading partners, you don’t have to dig too deep to find motivation for a rate cut.

Domestic consumption, which accounts for around 60% of German GDP, is in good shape and consumer confidence remains stable. Admittedly, other domestic German indicators such as the ZEW and PMI surveys also suggested things are not so bad but we can probably put this down to temporary positivity triggered by the ECB’s bond-buying plan. The German business climate survey has built up a strong correlation with German GDP, which leads us to believe a Q3 contraction is on the way. Weak exports are likely to outweigh robust domestic demand.

Still, the ECB seems unlikely to cut interest rates next week. The ECB appears to have already factored in further weakness in eurozone growth; recently projecting a 2012 GDP contraction of between -0.6% and -0.2%. This latest poor figure from Germany probably does little to change the ECB’s approach. Indeed Draghi acknowledged a weaker business cycle in his September ECB Press Conference.

In addition, the ECB’s Nowotny has recently stated that he “sees no need to change interest rates in the eurozone currently.” ECB policymakers have also been lauding the positive response in the financial markets to the ECB’s bond-buying plan, suggesting they are satisfied with the 0.75% interest rate at present. Draghi will also be eager to keep the German ECB policymaker Weidmann on side by waiting until a rate cut is absolutely necessary, when German growth has completely ground to a halt and inflation has eased further. This is likely to happen later on in Q4, perhaps in December. The euro is certainly feeling the pressure at present but it will likely be spared the downside factor a rate cut for the time being.

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Round-Up: Spanish bailout issue to weigh on euro

Market frustrations with Spain on the rise

Spanish PM Rajoy’s failure thus far to accept the inevitable and make a formal request for a bailout has weighed on the euro in recent sessions. The week ahead brings plenty of interest; we are due to see Spain’s draft budget for 2013, the results of the Spanish banking sector’s recent stress tests and an economic reform programme that is likely to be a prelude to a bailout package. Even if these developments are welcomed by the market, we still think that Rajoy will wait until after Spain’s regional elections on October 21, which leaves several more weeks of uncertainty and frustration. This should delay any further euro rallies.

On the Greek front, we have seen some alarming headlines that the budget deficit is nearly twice as large as initially estimated. Talks between Greece and the Troika are now on a one week hiatus, so the market is left with alarming rumours of the need for a third Greek bailout and another Greek debt restructuring. The option of granting Greece more time to meet its bailout targets is gaining support but at this stage we are very much in speculation territory.

Concerns over eurozone growth have returned to the fore this week, after another awful German business climate survey. The risks of a German recession are rising, a development which the periphery can ill-afford.

Sterling firm ahead of final GDP number

The pound is performing well across the board at present. Eurozone concerns have returned after an August lull, while the central banks of Japan and the US have both eased monetary policy further, leaving sterling to reap the rewards. In addition, UK data has improved in recent weeks and the BoE seems to be content for the time being to delay any further QE of its own.

Sterling should be able to hang on to its recent gains against the euro and perhaps even build upon them, provided that Thursday’s final UK GDP number for Q2 does not suffer a downward revision to the already worrying   -0.5% reading. This release, which is likely to remain unrevised, is the only major event on the domestic calendar this week. By and large, the market’s gaze will be firmly fixed upon Spain.

US dollar soft after QE3 decision but continues to look poised for a bounce

Sterling remains at heady heights close to a 13-month high against the US dollar, thanks in no small part to the Fed’s decision to do a third round of QE earlier this month. However, the dollar’s behaviour since the decision suggests the move was more than a little bit priced in. Certainly the pound has climbed against the greenback but it has really stalled at the $1.63 level, so much so that we expect the rate to fall back in the coming weeks (provided that Rajoy doesn’t surprise us with an early bailout request)

End of week forecast

GBP / EUR	1.2625
GBP / USD	1.6150
EUR / USD	1.2800
GBP / AUD	1.5600

Risk appetite is pretty weak at present and the flow of news out of the eurozone is predominantly very negative. There remain disagreements over the EU banking union, over the legality of the ECB’s bond-buying programme, over the cession of Catalonia from Spain and much more besides. With this in mind, the GBP/USD rate’s ceiling of $1.63 looks likely to hold firm in the coming sessions. Meanwhile against the euro, sterling looks better placed to climb further. A move back up above €1.26 is a likely one this week.

Richard Driver

Currency Analyst

Caxton FX

German confidence tumbles again, pointing to possible German recession

A monthly German survey, which covers around seven thousand firms, has been released this morning to reveal that German business confidence has declined for the fifth consecutive month. A flat reading was expected but German business confidence has now dipped to its weakest level seen since March 2010. The news provides further evidence of the dampening effects of the eurozone debt crisis on the region’s powerhouse economy and has accordingly weighed on the single currency today.

Firms in manufacturing, construction, trade and industry were mostly responsible for the poor climate reading, though retail and wholesale trade did improve slightly. The regional downturn is having a particularly noticeable impact on Germany’s exports to other eurozone nations. The economic weakness being seen in major nations like Spain, Italy and even France cannot be viewed in isolation; recessions are particularly contagious in a currency union like the eurozone and this morning’s data indicates that Germany is succumbing.

Interestingly though, an economist from the producers of the data - the Institute for Economic Research - has stated that German consumption remains robust despite a weaker labour market and therefore does not see a need for an interest rate cut from the European Central Bank. An interest rate cut would however weaken the euro, which could boost exports outside the eurozone, though this would require Germany’s preoccupation with high inflation to be set aside. The IFO economist did also note that the survey was taken prior to the positive decision from the German Constitutional Court earlier this month, the uncertainty surrounding which may be at least partly responsible for the unexpected decline.

The economic downturn is not just bad news for Germany but for the eurozone’s peripheral nations as well. If Germany enters recession, then it is going to be increasingly difficult for Merkel to justify and deliver the support she is pledging for struggling nations like Spain and Italy. With plenty more austerity measures still to come across the eurozone, the prospects for the economy as a whole and Germany by association, are rather gloomy. After Q2’s 0.3% GDP growth, Germany may avoid economic contraction in Q3 but the same is unlikely to be true in Q4, such is the downtrend that is in place. This is not to say that Germany is certain to enter a recession but the risks are very significant and it is looking increasingly likely, which is bad news for all concerned.

We may have seen some progress on the debt crisis in the last month or so but economically, the region is in very poor shape indeed, which is in part why we maintain a negative outlook for the euro.

Richard Driver

Currency Analyst

Caxton FX