Confidence in the UK economy waning

Publication date: 21 March 2011
Author: Duncan Higgins, CaxtonFX

Heightened volatility continued to characterise the market last Friday, as we saw the G7 agree to an historic coordinated currency intervention in response to aggressive yen appreciation. G7 central banks converted their yen reserves into their national currencies, triggering a sharp yen decline. Only time will tell as to whether this intervention can prove successful in the longer term.

This week is a far busier one for UK-related data; headline inflation and the MPC minutes are released mid-week, as well as the UK budget announcement. Confidence in the UK economy is waning, and the pound is suffering as investors increasingly scale back expectations of a June BoE rate rise; distinctly positive UK data this week is necessary to reverse this trend.

Meanwhile, Thursday and Friday’s EU Summit represents the eurozone’s deadline on resolving the region’s debt problems, on which the euro’s medium-term outlook relies; failure to agree could push Portuguese bond yields into bailout territory.

STERLING/EURO:

Huge euro-buying from the ECB saw sterling slump further against the single currency on Friday, dropping half a cent below €1.15.

Sterling continued to suffer in the wake of awful UK consumer confidence data as sentiment increasingly points towards a weaker UK recovery; Thursday’s monthly retail sale figures will provide investors with more clues.

Meanwhile, the euro immediately benefitted from an apparently disproportionate ECB intervention. Whilst EU officials are stressing that they will reflect on an interest rate rise with Japan in mind, the markets are still confident of an April hike with Trichet’s comments on Friday remaining hawkish. Faith in a similar BoE rate hike in June is waning and the pound is set to struggle in the short-term.

STERLING/US DOLLAR:

Sterling performed strongly against the greenback on Friday as the latter suffered a broad sell-off from central bank intervention. Sterling climbed to a ten-day high above $1.62 and continues to outperform the dollar this morning.

Higher stocks and a weaker dollar across the board reflected easing risk aversion in response to the G7’s assertive and unified action. The dollar also failed to capitalise on Friday’s Libyan cease-fire, which saw crude oil prices drop 1%. The UN’s military intervention may see a resurfacing of dollar-positive risk aversion this week.

Sterling may have been supported by some moderately positive comments in the BoE’s quarterly bulletin, but investors will take much more convincing from this week’s important UK economic announcements.

EURO/US DOLLAR:

The single currency performed well against dollar last Friday and continues to do so this morning, currently trading at just over $1.41.

Investors in the single currency were comforted by German Chancellor Merkel’s regional election wins over the weekend. This week brings further updates from eurozone manufacturing, industrial and services sectors and investors will follow the EU Summit closely.

The euro benefitted from easing concerns over the nuclear crisis, but Moody’s has released a very negative appraisal of the Japanese disaster and the military intervention in Libya may also support a return to risk aversion.

STERLING/AUSTRALIAN DOLLAR:

Sterling is losing ground for the third consecutive session this morning amid improved risk appetite following the concerted efforts of the G7 on Friday.

The action taken by the G7 to weaken the yen helped to stabilise the financial markets, which had been in disarray amid the turmoil in Japan and unrest in the Mideast. The aussie clawed back over two cents on Friday and has gained another cent today bringing the price back down to 1.62.

Overnight the Asian markets performed well with progress seemingly being made on the Japanese nuclear reactor, adding to the more positive risk mood. The market has now pared back expectations of an Australian rate cut at its April meeting. However, events in Libya, Bahrain and Japan could yet prove risk adverse and we doubt sterling has too much more downside potential.

STERLING/NEW ZEALAND DOLLAR:

This pair is continuing to move in tandem with sterling/AUD, with the pound ceding ground in recent sessions but still trading comfortably above 2.20.

Support from the G7 has given the edge back to the higher-risk currencies. Adding to the improved mood, Asian equities were stronger overnight with the MSCI Asia Pacific (excluding Japanese markets which are closed for a bank holiday) rising 1.1%.

Sterling is currently down, trading at 2.21 this morning but again downside appears limited as events in the Mideast could still prove triggers for selling higher-risk currencies. In addition, New Zealand’s fourth quarter GDP figure is due on Wednesday and is likely to show very weak growth, which will likely put downward pressure on the currency.

STERLING/CANADIAN DOLLAR:

Despite intervening action from the Bank of Canada on Friday, the loonie lost ground as oil prices came away from their highs.

The pound briefly touched 1.60 at the end of last week with the Canadian currency lower across the board. However, with military action now being authorised in Libya, oil prices are once again on the rise, boosting demand for commodity linked currencies.

With oil looking set to continue its steady climb, the pound is going to struggle to hold onto its recent gains with the price currently heading down to 1.59.