Sterling drops to 15-month low against euro

Tom Tong01/Jul/2011Currency Updates

GBP

Sterling slid to a 15-month low against a trade-weighted basket of currencies and the euro on Thursday on month- and quarter-end selling, with more losses likely as investors add to bearish bets on the view that UK rates will stay low in the near-term.

This sentiment was reflected in an amendment to its forecast by Barclays Capital, which now expects the Bank of England to raise rates by 25 basis points in May 2012, compared with its previous forecast for a rise in November 2011.

It said it has pushed back the timing after downgrading GDP forecasts. BarCap also saw indications that the bank’s rate setting committee was particularly sensitive to the domestic demand outlook and was especially worried by the weakness of household consumption.

The bank’s quarterly Credit Conditions Survey showed that British banks expect demand for business credit to level off in the third quarter of the year, after rising in the second quarter.

Analysts say a rather gloomy outlook for the economy would keep the pound subdued against the euro and growth-linked currencies such as the Australian dollar.

A private sector showed on Thursday that consumer confidence fell in June while house prices were flat.

Sterling also suffered on Tuesday as Bank of England policymakers kept alive the possibility of more monetary easing if the economy’s anaemic recovery slows even more.

EUR

The euro rose to its highest level since mid-March 2010, with traders citing steady month-end demand from a Eurozone central bank and a US investment bank.

The single currency was boosted by news that Greece’s parliament had approved a second bill of austerity measures and by favourable interest rate differentials. Analysts said the approval of the austerity measures had put to rest immediate worries about a default by Greece and the risk of contagion. This was likely to give a short term boost to riskier currencies.

European Central Bank President Jean-Claude Trichet reiterated his hawkish bias towards inflation, backing strong market expectations that the bank will raise rates next week.

USD

The recent need for liquidity and an alternative to the euro further evaporated during Thursday and the dollar subsequently found the fundamental support it gathered during June collapse extending the bearish reversal that began the week.

Whilst it’s easy to label the dollar a ‘safe haven’ currency, it isn’t the risk-free asset such a term would suggest. There is a high level of financial volatility and extremely little return with the reserve unit; so its appeal when conditions are uncertain is flimsy at best. Where the greenback really shines is through its liquidity. The build-up of panic surrounding the European financial markets heading into this week was severe enough to drive up the cost of short-term funds in the Eurozone and US. This had the dual impact of sending investors scrambling for the deepest markets (US Treasuries and money markets that are closely linked to the greenback) as well as boost short-term rates that cut into carry trades that were founded on extraordinarily cheap loans from the US. Now, with the imminent threat of a Greek default developing into a global crisis fully dissipated the need for liquidity at the expense of a competitive yield gone. That does not fully absolve the market from broader risks but the short attention span of this heavily speculative market can certainly buy time.

Today’s key US data to watch includes Revised University of Michigan Consumer Sentiment and the ISM Manufacturing Purchasing Managers Index. It is also important to note that Monday is the US Independence Day public holiday.

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Written by Tom Tong

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