F/X weekly comment

Timing is a vital ingredient in F/X forecasting. Had this week ended on Thursday, my forecast would have been spot-on at 1.17. As it is, we have drifted back and the pound is now back under the 1.1600 level. It has been an interesting few days however, and could get more interesting in the coming weeks. Here is what happened this week:

Interest rates
The Bank of England left interest rates at 0.5% on Thursday. We have now been at that level for a full two years. No rational onlooker would have expected anything else, but it appears as though some market players were holding out for an early rate hike, and the pound was sold when this didn't happen. I don't actually expect anything to happen next month either, and it's touch and go whether they do anything in May. There is a school of thought that favours August on the basis that government cuts will hurt the UK economy more than the coalition expects, and therefore growth could slow in May. Recent signals that the ECB is nearly ready to hike Euro rates will not help sterling.

Inflation
Friday was a busy day for figures, with inflation reports for the major European economies released showing that prices accelerated in February as debt woes continued to occupy traders' minds. German CPI data showed that prices surged at the fastest pace in more than two years last month, driven by the rise in commodity prices. Inflation in Germany rose to 2.2 percent, in line with market expectations. The German economy has of course been driving the Eurozone recovery. New jobs are being created, bringing unemployment to the lowest level in almost 20 years, but inflation is on the way up as oil prices surge. Heating oil rose 32% year on year, while fuel prices have risen 12% since January.
UK Producer Prices provided no great cheer here either. Input prices increased by 1.1 percent last month, with an annual price gain of 14.6%, the fastest rate in thirty months. This puts more pressure on the BoE to contain inflation, and that means rate rises. Consumer Prices rose in February by an annualised 4%, double the desired rate set by BoE at 2% and the upper limit set 3%.

Debt
Spanish. Lots of it. So much that Spain’s credit rating was cut yesterday to Aa2 by Moody’s, which said lenders may need as much as 50 billion Euros to meet new capital adequacy rules. The Bank of Spain said its estimate of 15.2 billion Euros may end up lower as some savings banks opt for stock listings that will reduce the amount of capital they need under Spain’s new rules imposed last month. Some chance!
Spain is desperately trying to stem contagion as investors fear that Portugal may need a bailout and Greece and Ireland will lobby to renegotiate rescue deals. Prime Minister Zapatero’s government is seeking to show that his banks can survive a fourth consecutive year of economic slump and a jobless rate of 20 percent, as bond yields on the PIGS surge.

So what now?
We woke on Friday to see images of the tsunami bursting over Japan's shores. This is a real biggie, and could have a great effect on both equity and currency markets. Things could get a bit 'choppy' in more ways than one. It might even have the effect of diverting attention from more mundane matters, in which case I suspect that we will not see much change in the exchange rate this week. Sterling in the 1.16s for me.


A bientot, Rob