Weekly Currency report

From Peter-John Theuninck, Currency Analyst at Baydonhill FX

Sterling struggled last week as negative market sentiment drove traders to sell the Pound in favour of the Euro and the Dollar. The Pound reached a 2 ½ year low against the Dollar as speculation over the UK annual budget announcement weigh on Sterling, investors expect George Osborne to announce a review of the Bank of England’s remit and opening the door for more aggressive monetary easing measures to be introduced.

Sterling has declined over 8 ½ percent against the Dollar since the beginning of this year, reaching below 1.4850 to post levels close to the those seen in the aftermath of the financial crisis. Technical reversals against Sterling’s sharp declines pushed the UK currency briefly through 1.52 as supported came from comments by the Bank of England Governor Mervyn King, who labelled the current value of the Pound as being ‘deemed appropriate by the market’, a neutral BoE minutes and a fiscally responsible budget from the UK treasury.

The Bank of England minutes provided no real surprises as the monetary policy committee voted 9-0 to keep interest rates at 0.50% while the vote in favour of quantitative easing was 6-3 as expected.

The annual budget speech was where most of the market’s uncertainty was focused. Chancellor of the Exchequer George Osborne’s budget announcement was met with support for the Pound as he reaffirmed that Bank of England was primarily focus on price stability and the 2.0% inflation target remained unchanged. The Chancellor acknowledged that conditions in Britain remained difficult and confirmed the UK central bank would be free to use whatever unconventional policy measures they deemed necessary to support a growth economy.  

The Euro came under pressure after the shocked announcement of a bailout plan for Cyprus that would levy a tax on bank deposit holders. The fear of contagion to these radical measures saw market participants move out of the Euro and return to the relative safety of the Pound and the Dollar.

The lack of an agreement for a Cypriot bailout after the government rejected the EU plan and week data from Germany, kept the pressure on the Euro. The Cypriot government rejected the proposed bailout plan early in the week and met with Russian official to discuss possible support. Negotiations with Russia offered no solution to the Cyprus problem and has left the country at the 11^th hour to come up with an alternative plan that would keep the European Central Bank supporting its heavily indebted financial sector.

German economic data placed further pressure on the single currency as manufacturing activity fell unexpectedly in March. The German PMI manufacturing index came out at 48.9 versus an expected 50.5 and the previous 50.3 expansion level. The contraction in manufacturing activity raised concerns that the Euro-zone may not be quite as stable has the market had assumed. Service sector activity in Germany was equally alarming as the rate of expansion in this sector of the German economy fell considerably in March.  

The US Federal Reserve Bank kept interest rates unchanged as expected but also confirmed they remained committed to ongoing monetary easing. Recent economic data releases had led to investors speculating that the Fed may signal an intension to slow down or end its bond buying program which was strengthening the Dollar.

The Fed cited a number of factors that supported its decision to continue with its quantitative easing program; global risks from the Euro-zone crisis, the automatic spending cuts that came into effect at the end of February and of which congress has yet to reach an agreement, and unemployment levels that are still above what the US central bank would need to view the US recovery as stable.

The Dollar saw a good deal of safe haven demand on the back of the uncertainty in Europe and hopes that more QE would not be introduced by the Fed, the confirmation that an end was not in sight put pressure on the US currency through the later part of the week.    

This Week

There will be two consecutive short trading weeks that will see reduced volumes impact the Sterling market. The Pound is likely to come under some pressure at the end of the week as traders prepare for UK market being closed on Friday the 29^th and Monday 1^st April.

The Pound’s rally is set to run into some resistance early on as traders await the release of final fourth quarter UK growth data. UK GDP numbers are being released on Wednesday at 09:30 (GMT) and analysts are not expecting any revisions to the -0.3% previously released.

The confirmation of negative growth in Britain will likely weigh on the Pound after a week-long rally as traders once again price in increases to quantitative easing (QE) by the Bank of England. Sterling’s only saving grace may be that the time frames for a boost in stimulus have more than likely been extended by last week’s BoE minutes and UK budget announcement. This would mean a QE increase in May rather than April.

There are a number of additional economic data releases to take note of over the coming week. The CBI distributive trades and GfK consumer confidence numbers are all set to be released over the course of the week.

UK distributive trades data will be of greater interest than the consumer confidence index, especially after last week’s events that suggested the UK government and Bank of England still expected a protracted and difficult economic recovery for Britain. The market is expecting an increase to the distributive trades data index to 11 from 8 in March.

Cyprus is likely to continue to create uncertainty in the Euro-zone as even with an 11^th hour bailout deal the country’s financial sector remains in dire straits. The bailout agreement would secure ongoing financial support from the European Central Bank but banking reform would still be needed to stabilise the Cypriot economy.

German economic fundamentals have recently added to the Euro’s woes so traders will be keen to see whether the retail sales index will follow suit. German retail sales, being released on Thursday, are forecast to have fallen in March, which will not be positive for the Euro. The index is expected to show a drop of 1.0% in February compared to the 3.1% increase in January sales.

German unemployment numbers will also be published on Thursday although no change is expected to the 6.9% rate. The data will also not be overly supportive for the single currency.

Market sentiment toward the Euro is likely to remain negative this week as international concerns over the Euro-zone continue to weigh on the region’s currency.

The Dollar will remain a favoured safe haven currency to guard against the risks in Europe and likely to see ongoing support throughout the week. The is not to say that the Dollar will strengthen significantly but losses as the market retraces on the Dollar’s recent appreciation trends are expected to be limited to some degree.

US final GDP for the fourth quarter of 2012 will be released on Thursday and is forecast to show an increase to the previous figure. The data comes after the Fed raised concerns over the impact that the automatic spending cuts would have on the US recovery and should the data follow the markets expectations, the Dollar is likely to rally of off this data.

US durable goods and weekly jobless claims data will also be reviewed in context of Fed policy but neither data release is likely to alter market expectations for future Fed action. The US durable goods index is expected to show a sharp increase in orders for February that may see traders buying the Dollar on the hope that the Fed may be encouraged to review the position on stimulus, however unlikely such a change might actually be.

Friday will see lower trading volumes as the Good Friday holiday will see many market in Europe closed, including the United Kingdom. The expectations will thus be for US traders to keep the Dollar trading along the same risk guidelines as were seen earlier in the week. This would suggest that the Dollar may very well continue to see support but not to the point of break out of the week’s ranges.  

Economic Data