Sterling rises on prospects for negative Euro rates
25/Nov/2013 • Currency Updates•
A relatively quiet week saw sterling rise moderately against most major currencies, buoyed mostly by negative developments elsewhere. On Wednesday, a report made its way around markets that the ECB was considering negative rates (although President Draghi later insisted that there was “no news” on the issue. Elsewhere, dovish pronouncements from various Central Banks (most prominently, Australia´s and Japan´s) buoyed sterling, which ended the week up anywhere from 0.4% against the euro to 1% against the weakest major currency, the Japanese yen.
In the absence of major macroeconomic releases, investors were focused on the minutes from the November meeting of the Bank of England. These were more cautious than most commentators, ourselves included, were expecting. The BoE is quickly backing away from the 7% threshold for raising rates. The minutes made it clear that the MPC strongly disagrees with market expectations of a mid-2015 hike. Markets received the release with a shrug. After a short and shallow dip, both sterling and rates quickly recovered and ended the week higher. We think that the next few speeches from MPC members will be critical to ascertain the extent to which recent economic strength is discounted by the Bank. We think that sterling strength against the euro is likely to continue, whereas the currency may be getting ahead of itself against the US dollar.
Macroeconomic news out of the eurozone maintained their pessimistic tone last week. The PMI business sentiment indicators underscored that the worst recession in European history is now being followed by the weakest recovery. The headline composite index pulled back from 51.9 to 51.5. While the drop is not dramatic, the possibility that growth may be peaking below the 1% level is quite unnerving given the the job market has yet to bottom out. Particularly worrisome was the fact that France relapsed into contractionary levels at 48.5.
A report out of Bloomberg that the ECB is considering negative rates confirms our view that the ECB is quite worried about the lackluster recovery and the risk of outright deflation. While President Draghi sought to dampen speculation stating afterwards that there were “no news”, we think that negative rates are a distinct possibility at the January meeting unless December news and in particularity inflation figures, take a turn for the better.
The dollar somewhat surprisingly failed to rally last week. The release of the minutes from the last FOMC meeting was more hawkish than the market expected, though in line with our expectations for a January start to the taper. Retail sales rose 0.4% in October MoM and 3.9% for the year, a level which is roughly consistent with real demand growth around the 2% level. Together with continued impetus from the labour market and at least a neutral contribution from net trade, we believe that growth in the 2-2.5% range is perfectly achievable both this year and next.