Weekly Currency report

From Peter-John Theuninck, Currency Analyst at Baydonhillfx

The Dollar saw a great deal of safe haven demand last week as the debt crisis in Europe continued to drag on and the Bank of England expressed concerns that the events within the Euro-zone were beginning to have an increased effect on the British economy.

A slim victory by the pro-bailout centre-right New Democracy in Greece’s elections eased concerns for a sudden exit by the country from the Euro but  while the news was positive the long-term effects were seen as limited since bailout conditions still need to be met by the Greek government to ensure the country remains liquid. The markets proved to be less than confident in the Euro-zone as Spain remained a focal point for investor concerns and Germany showed a weakening in economic fundamentals later in the week. Ratings agency Moody’s downgraded a number of major European banks last Thursday creating a renewed ‘risk-off’ cycle in currency markets that dragged the Euro lower across the board.

Sterling was greatly influenced by the effects of ongoing investors concerns towards Europe’s debt crisis ahead of the highly anticipated Bank of England (BoE) monetary policy committee meeting minutes released last Wednesday. The BoE minutes delivered a unanimous vote to keep interest rates unchanged, as expected, but the split vote on increasing the UK central bank’s quantitative easing program came as more of a surprise. The MPC voted 5-4 for keeping the value of the asset purchase scheme unchanged at $325bln. The 4 members that favoured an increase were BoE Governor King and members Posen and Miles who voted for a £50bln increase while member Fisher felt a £25bln would be sufficient over the short-term. The minutes raised speculation that an additional cash injection for the British economy was virtually guaranteed at the UK central bank’s July policy meeting and subsequently weighed on the value of the Pound.

Safe haven demand for the Dollar while a dominant theme in the market only really impacted the currency in later part of last week. Prior to investors scaling back on their Euro positions and cutting their risk exposures the market was focused on the US Federal Reserve Bank’s (Fed) interest rate decision.   

The Fed extended its rebalancing operations by announcing a $267bln increase in the swap of short-term securities for longer term ones in order to keep long-term borrowing costs down. The additional ‘twist’ operation was seen as necessary by the US central bank due to ongoing concerns that the prolonged European debt crisis was dampening US economic activity.

This Week

The markets opened with a distinct bias to risk aversion today after the various central bank events last week cast a shadow over the hopes that a global recovery was well and truly on track.

The Euro is maintaining its downward trend today as market participants look ahead to the European summit later this week. Germany, France, Italy and Spain have all recently indicated being in favour of ongoing broad-based financial support for EU member countries and the European Central Bank (ECB) has taken a similar stance by widening the range of acceptable collateral for ECB loans. The market does not share in the EU leaders more positive overtones though as the single currency remains under pressure and expectations remain for a bias towards a softer Euro throughout the week.

The negative elements in Europe as quite clear but that is not to say that there aren’t any positive aspects to consider either. Economic fundamentals being released this week will certainly not be overlooked, especially the release of German inflation, retail sales and unemployment numbers. Economists are forecasting a lower German CPI inflation figure that will undoubtedly strengthen the EU central bank’s ability to undertake liquidity operation without the concern of stoking inflationary pressures, thus boosting the benefits that the added liquidity can have of the Euro-zone economy. The forecasts for the  release of Germany’s retail sales index on Friday are quite positive while the country’s unemployment rate is expected to remain unchanged.   

Unsurprisingly the Pound is being heavily influenced by risk aversion towards the Euro and the appreciation of the Dollar. These influences are unlikely to abate this week as traders prepare for the EU summit. That said Sterling will not be totally dependent on wider markets movements as a number of significant data releases will affect the UK currency. UK government spending figures are expected to be released tomorrow and the surplus posted the previous month will return to a deficit position in May as April’s one-off factors have worked their way out of the public finances. The data is not expected to be an overriding negative though as the March debt figures were over £16bln while forecasts for May stand at £14.8bln.

The main concern for the Pound this week will come from the final first quarter GDP release. Even though the market is expecting no change to the previous -0.3% q/q estimate in Q1 growth, general risk aversion in the market could see a negative reaction towards the Pound as low growth coupled with the higher risk of a knock-on effects from Europe raises concerns over the ability of the British economy to handle further global shocks.

The Dollar continues to see support as traders and investors look to minimise their risk exposures to Europe and other higher risk investments. The impact of a ‘risk-off’ market strategy is unlikely to ease this week although the opportunity for profit-taking against the Dollar remains ever present. After the Federal Reserve Bank (Fed) meeting last week indicated a concern for a slowdown in the US economy, fundamentals will the analysed to see if the risks are immediate or if a more measured approach can be taken towards potential weakness in the economy. US GDP is expected to remain unchanged at 1.9% for the first quarter while weekly jobless claims are again forecast to show a lower figure for the number of people claiming unemployment benefits.

The expectations of weaker UK GDP figures are likely to be priced into the value of the Pound quite quickly this week, placing downward pressure on Sterling, but until we know what, if any, debt action plans will be announced by the EU summit we would remain cautiously optimistic toward the GBP/EUR cross while maintaining a risk averse stance on GBP/USD.        

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