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Money & Finance

Sterling/Euro Currency Review December 2014

Wednesday 07 January 2015

After a disappointing end to November, Sterling experienced a mixed start to December before rallying towards the end of the month, says Ben Scott.

Despite another month where UK economic data disappointed in several sectors, euro buyers will be buoyed by Sterling improvements towards the end of December helped substantially by growing concerns of a pending financial crisis in Greece which resulted in a six year high for GBP/EUR of 1.2886 (Interbank throughout) as illustrated by point C on the graph below.

Deteriorating economic and political fundamentals have lead some commentators to suggest another Greek crisis is inevitable the Eurozone, however, falling inflation in the UK has again reduced the prospect of interest rate increases in the UK, capping Sterling gains and contributing to a month low of 1.2487 (16 December 2014), trading at an average rate of 1.2685 throughout December.

Sterling gains from point A came as a direct result of improved services sector figures, which accounts for a significant proportion of overall gross domestic production (GDP) and approximately three quarters of jobs in the UK. Sterling was also boosted by a positive Autumn Statement from Chancellor, George Osborne, who raised near-term growth forecasts for the UK.

Nevertheless comments from the Organisation for Economic Co-Operation and Development contradicted improved growth forecasts by warning of a "loss of growth momentum in the UK".

Despite disappointing industrial production data from Germany, the euro was able to gain support on the back of the European Central Bank (ECB) resisting ongoing pressure to introduce a full programme of quantitative easing (QE). This monetary policy as employed by other Central Banks, weakens the currency in question by adding more of that currency to circulation.

Sterling losses leading to point B came as a result of desperately disappointing economic data with UK industrial and manufacturing data both falling well below expectations.

Another key contributor to Sterling weakness was a lower than expected inflation reading for November, important consumer price index (CPI) figure showing inflation of just 1%. Although the Bank of England (BOE) had previously forecast a fall in inflation to 1%, the drop has come quicker than anticipated. With inflation expected to fall further as oil prices tumble, it seems certain that inflation will fall still further, reducing the potential of the BOE raising interest rates in 2015, making Sterling a far less attractive investment.

The pound’s weakness was compounded during this period by surprise improvements in economic data from the eurozone, including German manufacturing, trade balance and export data, but more significantly, a far better than expected ZEW survey which showed a continued improvement in economic sentiment for the area.

Sterling losses were quickly reversed immediately after point B as concerns continue to grow that Greece could be about to enter a third financial crisis. Soon after agreeing to an extension to the bailout as a result of deteriorating economic conditions, Greek Prime Minister Antonis Samaras called a snap election for the presidential post. With Samaras’ candidate failing to achieve the required support, meaning a general election is required (Greece goes to the polls on January 25th), with support growing for the radical hard left Syriza party.

The election of the Syriza party would almost certainly prove detrimental to the euro; the Syriza party already promise to defy the terms of the country’s bailout in favour of moving away from austerity and concerns grow that political and economic turmoil could spread throughout the eurozone. One report describes the Syriza Party’s plan as ‘worse than communism and total chaos.’

Outlook

Analysts are increasingly concerned by slowing UK economic data. Despite British retail sale figures towards the end of December, which came in at a 27-year high and gave an immediate boost to Sterling, wage growth remains sluggish raising the concern that borrowing is spiralling. Data now shows that unsecured debt is back to levels not seen since the onset of the economic crisis, raising serious doubts regarding the sustainability of the economic recovery in the UK.

Elsewhere, whilst falling oil prices has a direct impact in driving inflation lower, which is Sterling-negative, in as much as it reduces the prospect of an interest rate hike. Lower oil prices could boost recent underwhelming data by reducing the cost of living, which would improve spending in other areas. BOE Governor Mark Carney highlighted this point by stating “Oil drop could support economic growth”.

Euro concerns, as a result of disappointing economic data, looks set to continue in the medium-term. The most pressing issue for the ECB remains QE and the ECB’s reluctance to announce a full programme of QE seems to leave the euro vulnerable as speculation continues to drive the market.

Whilst the German ZEW report does show improved economic sentiment, the report does indicate an expectation amongst business leaders that the euro will weaken further going into 2015. Although negative for the value of the single currency a weaker euro will improve the competitiveness of exports from the eurozone, which would in turn lead to economic improvement.

Ben Scott
Foreign Exchange Ltd
www.fcexchange.co.uk

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