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Keith reviews the summer currency market and shares his views of what the autumn holds for the euro and the pound.

Pound enjoys improved summer

Although the pound enjoyed a sustained 1.20 – 1.22 range against the euro throughout the much of the summer, the beginning of Autumn will prove somewhat troublesome for strategists, economists and policy makers as holding at this higher level will exacerbate fears of a double dip recession and cause concerns over the fragility of the UK’s economy, thereby undermining consumer confidence and alienating the private or retail investor.

Double-dip  recession?

The potential for a double-dip recession is the most prevalent concern for the Government at the moment. The Con-Lib coalition has until recently been ignoring the effect of its austerity measures on growth, preferring to talk up their moral compulsion to act swiftly, but glossing over how significant an impact they will have on unemployment and consumer confidence in the wider economy. Credit and access to liquidity for small to medium sized businesses is still a very big issue and has been since the beginning of the financial year. Whilst one should remain optimistic about Britain’s ability to weather a potential return to negative growth in the long term, in the short term the pinch is genuinely yet to be felt by many households. Youth unemployment is the highest it has ever been, and this is not because employers don’t want to take on new staff out of principle, it is because their access to cash has been cut off by the banks who are challenging the viability of the majority of SMEs based on their disappointing performance over the past 18 months.

Retailers have benfited

Over the past two years retailers have benefited from an increase in the foreign footfall in high profile shopping destinations like London. The weakness in the pound meant that retail sales figures were higher than expected over the summer of 2010 with an influx of foreign money coming from Europe, the US, Australia and South Africa; but the improvement of the pound against a number of major currencies since Prime Minister Cameron came to office, coupled with a rather inflexible attitude towards visa applications for tourists and students from the emerging markets, may cause the MPC and the Government to take a closer look at who, if anyone, is really benefiting from a stronger pound at this stage. It is fair to say that importers are enjoying a little respite because they are able to buy cheaper within the EU, but the exporters are increasingly worried that the pound’s improvement since May has already dented the UK’s chances of a sustainable recovery and its competitiveness globally. It must be conceded that 14% of British GDP is based on the export market, but UK Plc needs all the help she can get given fierce competition from Germany and the Far East.

Speculation of UK interest rate rise

One of the main drivers behind the improvement in the pound has, and continues to be, speculation over the increase in UK interest rates. Traditionally an increase in interest rates is the default measure used to curb inflation. Strangely though, the Governor of the Bank of England stated earlier in the year that he expects inflation to settle down by the end of the year anyway, which highlights a stale mate between liquidity and risk within the banking sector. More money being brought into the markets would grease the wheels of the retail sector because small businesses are able to borrower at fairer rates. Quantitative easing is likely to be raising its ugly head again over the coming few months, precisely because the Bank of England can’t afford to use interest rate increases as a weapon against inflation. One has to question why the market is so optimistic about rates going up, and going up quickly in the beginning of 2011. Banks including RBS are widening their margins when it comes to loaning to individuals. House prices are in fact dropping fractionally despite limited stock that would normally see demand increase and thusly values go up. So we are still clearly sitting very much in a credit dry market.

For more information on currency exchange you can click here.

For more information on currency exchange you can click here.

For more information on currency exchange you can click here.

Little movement.

Over the past 72 hours GBP/EUR has moved painfully little.  The average range over the latter half of this week for this usually animated currency pair has been a mere 85 points, meaning that traders have either been waiting to move based on poor or positive economic data, or other markets have attracted their attention.  This other market is the US dollar.  This has taken a beating against both the pound and the euro on the back of poor unemployment figures, and in anticipation of sluggish growth going forward.

Mervyn King with be speaking later on next week, and hopefully this will ignite interest in European transactions.  UK financial earnings have been positive overall, and this may have helped to hold the pound at around the 1.20 level, but the pound will no doubt come under pressure over the course of the next trading week, and the markets will wait with baited breath to see what sentiment Governor King chooses to express.  He will make a point of mentioning the level of lending to SME’s and individuals, and with banks such as RBS widening their profit margins it seems that pressure regarding capital adequacy is coming to bear and affecting borrowing criterion.

The Germans seem to emerging from something of a lull which suggests that next week could prove euro positive up to a point; at least we should see some movement after what has been a distinctly uninspiring five days.

Would you trust an economist?

A strange question you may think but maybe not when you consider that if you invited 10 economists to dinner and asked them to forecast the economic outlook for Europe for the next 12 months, not only would you probably lose the will to live, but you would also get 10 very different answers.

Remember, you can count on one hand the number of economists who predicted the current downturn, so how can they really predict the upturn when it comes? The reason I muse upon this is that for the past month the economic data coming out of Europe and the UK is confounding the critics who indicated that the tough austerity measures would see another slump, as it in fact indicates that we could be seeing the famous green shoots of recovery.

Stellar July for Euro

The Euro has enjoyed a stellar July as it safely passed the bank stress tests, or as I call them, the exercise of rearranging the deckchairs on the Titanic. But whatever your view, the market certainly liked what it saw, even though many of us still have lingering doubts about the state of the European banking system… but hey “why let the facts get in the way of a good story.”

German unemployment falls

German unemployment fell for the 13th straight month in a row and manufacturing data points once again to growing exports for northern Europe. Last month I highlighted the lack of safety deposit boxes in Madrid, and this was taken by some as a sign of a weak Spanish banking system. The point I was trying to make is the black economy is thriving, with an estimate of €17 billion being diverted out of the eyes of the tax man each year. Again it’s no coincidence that 85% of all €500 notes are in circulation in Spain and I doubt many of them pass over the counter of your local Caja. So despite a crippling rate of unemployment above 20%, with most of this inflicted on the youth, Spain is surviving.

Inflation a problem for the Bank of England

In the UK the Bank of England’s main problem is inflation and as far back as March this year they said that the tough austerity measures to be brought in would curb this rate. Well that hasn’t happened; inflation continues to stay “sticky” and if anything looks like it may rise. The last BoE vote on interest rates even saw one member call for a rate rise to combat the inflation problem. It’s unlikely we will see a rate rise in 2010 but the threat of inflation is there and can’t be that much of a surprise since the BoE printed an extra £250 billion to keep the economy afloat.

USA heading for a serious fall

Now the real basket case is the US who are heading for a serious fall. Obama’s plan to chuck trillions of dollars at the US economy is looking like a huge mistake. At a time when Europe and the UK are embarking on a series of austerity measures like the world has never seen, Obama is spending, spending, spending and “worrying about the bill tomorrow.” But that bill has to be paid sometime and since the meltdown in 2008, the US already owes the rest of the world an extra $3 trillion. California, which if measured as an independent economy would be the 5th largest in the world (yes really!) is effectively broke with many public sector workers being put on a 3 day week. So once again, all the economists who screamed about how the US would lead the world……nil points!

World a strange place

The world is a very strange place at the moment and I have my own view. I think the world has changed dramatically in the past 10 years the real money is now found inChina, India and the Middle East. We live in a facebook economy where employment can be found by recommendation and trends quickly established. The bloated indebted countries reside in the West, however if tough austerity measures are implemented they should survive intact. The Euro Zone still has a tough time ahead and needs a complete overhaul of its labour laws if it is to get youth employment on the rise again. However it’s not as bad as it seems…

But why listen to me? Economists are pointing to 2011 as another tough year when once again the World could tip back into recession………and they always get it right don’t they?

Keith Spitalnick LLB (Hons)

Regional Sales Manager

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