Euro and sterling boosted ahead of interest rate decisions on Thursday

Tom Tong08/Jan/2013Currency Updates

GBP

The pound steadied itself yesterday, managing to make gains against the dollar but losses against the euro, continuing its role as a low-beta version of the euro, stemming the gradual decline we saw last week following hawkish Federal Reserve minutes.

Conversely, analysts at Citi have warned that the Bank of England will have to keep printing money in order to stimulate the economy until 2017 at least, as well as capping interest rates at 0.5 per cent.

It is widely thought that there is a strong likelihood of the UK losing its triple-A credit rating this year. This follows on from the negative construction and services PMI data last week, which showed both sectors were contracting. This created doubts about the economic recovery in the UK, and fears that the UK could in-fact suffer from a ‘triple-dip recession’.

EUR

Despite political uncertainty, the euro managed to strengthen by 0.3% against the dollar ahead of the ECB’s monthly interest rate decision on Thursday. We saw a temporary decoupling of the euro from risk assets as stocks on Wall Street withdrew from their 5-year highs amid a sell-off in commodities and an increase in demand for safe-havens such as US and German sovereign bonds. However, despite this, the euro rallied amongst speculation that the ECB will keep interest rates on hold at Thursday’s monthly monetary policy meeting.

However, there is widespread expectation amongst investors that, with inflation coming down from previous highs within the eurozone, the ECB could cut interest rates from 0.5 per cent to 0.25 per cent this year; though this is unlikely to happen this week. This move in the euro was in spite of political uncertainty in Italy, as Silvio Berlusconi agreed an electoral pact with the Northern League; a development that could lead to no outright winner from the country’s parliamentary elections next month.

The euro was further boosted following a meeting between the Basel Committee of banking supervisors agreed to give banks four more years to build up their cash buffers to the requisite level, as well as allowing for more flexibility. This was seen as a positive for the euro as it aids the plethora of beleaguered banks in the eurozone periphery, in countries like Spain, Italy, and Cyprus in particular. Today, we see eurozone retail sales data, as well as eurozone unemployment and German factory orders.

USD

The greenback lost ground against major currencies on Monday, following strong gains last week, on the view that the Federal Reserve will wind down its bond programme this year. The dollar index, which compares the US currency against a basket of six currencies, declined to 80.2558 from 80.440 on Friday. The US currency had risen 1% last week after minutes from the last Fed meeting indicated that policy makers were keen to its quantitative easing programme. However, jobs data out on Friday took the wind out of the dollar’s sails after figures showed that while jobs were added in December, it was at a slower pace than November’s revised figure.

By Monday, dollar impetus was further hurt as focus switched to the European Central Bank’s meeting on Thursday. The ECB is widely expected to refrain from cutting interest rates at its meeting this week and markets will be eager to see if any indication of monetary stimulus is given.

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Written by Tom Tong

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