F/X Comment

My forecast last week was much more accurate, and we've ended this week just 25 points away from the 1.12 range, which is not good news for anyone looking to bring sterling over here and change it into Euros. I even got the basic reasoning right, and it was all down to interest rate movement.

Euro rates up
The European Central Bank raised its lending rate from 1.00% to 1.25% yesterday despite continuing Eurozone sovereign debt concerns. Portugal’s debt crisis surfaced again just before the rate hike, when Prime Minister Jose Socrates announced that he was forced to seek an ECB bail-out. European Finance Ministers are meeting as I write to thrash out the details of the deal, with some commentators predicting that the UK may be forced to stump up close to £4Bn in loan guarantees on Portuguese debt.
ECB President Jean-Claude Trichet hit the nail on the head when he stated that 'the hike is unwelcome for peripheral countries'. There is a real fear now that the interest rate hike combined with stringent austerity measures may lead to mass unemployment and a contraction in economic growth in the PIGs. It appears however that the ECB attaches more importance to rising prices in Germany and France than to concerns over growth fears for minor states with yesterday’s monetary policy decision. This can only cause long term damage to the viability of the Euro project.
There is a chance though that this rate rise will not now be the first of many, and recent events in Portugal, Ireland and Greece and fears over future funding problems in Italy and Spain may slow the return of Euro rates to 'normal' levels.

Sterling rates on hold
While the ECB was raising rates on Thursday, Merve and the boys at the BoE predictably sat on their hands and did nothing. This is the overwhelming reason why rates are where they are now, and it could get worse before it gets better. The PPI figure this morning came in at 3.7% against 2.2% expected, adding to expectations for a higher consumer price inflation number next week, which will add further pressure on the MPC to raise rates.
As long as the UK delays interest rate rises, the exchange rate will suffer, and we could even dip below the 1.10 level. However, with UK inflation heading towards 5% and the price of a barrel of Crude Oil reaching its highest ever level this week, it is possible that the Bank might wake up and adopt a more lively stance in coming months. This, combined with a need for the ECB to keep Eurozone rates lower than they'd like to in order to help the PIGs, could spark the long-awaited recovery for the pound.

So?
None of this is going to happen in a hurry, so I'm still looking at a dip into the 1.12's by next weekend.