Weekly F/X comment

Perhaps the less said about my forecast last week the better. 1.1675 doesn't look much like 1.1950 whichever way you look at it, so what did I get wrong? Euro weakness is the answer, and lots of it. Strife in the Euro camp. This week, Germany rejected a proposal from Luxembourg and Italy that a large chunk of euro zone sovereign debt finance should be replaced with collective Eurobonds, and the Luxembourg prime minister accused Ms. Merkel of being "un-European".

So what's wrong with good old-fashioned Eurobonds?
Germany has now rejected the idea twice. On Monday Germany's finance minister said it was unworkable on technical grounds, because the European treaties would not allow it. On Wednesday, Angela Merkel, the German chancellor, gave the real reason; that a collective Eurobond would provide the wrong incentives, allowing weak states to hide behind the strong. She believes that member states need the financial discipline of the bond markets and separate interest rates. Now to my mind that is indeed pretty un-European. I thought the idea was for a single pan-European interest rate? Apparently not if it means that Germany has to pay more than it needs to in the process.

End game?
It strikes me the eurozone's politicians will have to face the hard question next year of whether to help states such as Ireland engineer a managed default and exit from the euro or make concerted efforts to bring the eurozone into a tighter political and fiscal union and thereby facilitate economic transfers from strong states to the weak. The practical prospect of this happening seems somewhat remote, but without it we could now be looking at the start of the end game for the euro.

A chartist's view
One of my promises when I started writing these articles was that I would avoid technical mumbo-jumbo and chart-speak, so I will choose my words carefully here. Below we have a chart which shows the turbulent history of sterling against the euro over the past 5 years, or to be more precise the past 3 1/2 years. As you can see all was well in the world until half way through 2007, then we lost nearly 10% in the second half of that year. In 2008 the merde really hit the ventilateur, and we lost another 22%. Since then however we have seen a recovery of sorts in both 2009 and 2010. Here comes the technical bit.

Take a look at this link: http://markets.investorschronicle.co.uk/companies/summary.asp?YYY2070_05il4cW/O8fDu6TjdxyEB1/lYp2aAGZomAsCpdYn/Rg=

Look at the four troughs (lowest points) from December 2008 through to now, and mentally (or actually if you like) draw a line linking them all and carrying on into the future, that line will be going 'uphill'. Real chartists out there will be choking on their coffee at this point, but I'm not talking to them. This is called a trendline, and if the chart does indeed carry on in this way sterling will be back above 1.3000 sometime in 2012.

Now I know for a fact that Barclays have lots of chartists, and the bank seems to be listening to them. The bank`s long-term forecast is for sterling to reach €1.28 by this time next year. Barclays view is that “The Coalition is enacting deep structural reform in order to take a lump out of the deficit, which is a risk…It could ultimately be good for the structural growth story in the UK.” Yes, well, maybe and maybe not. I have my own view on the Osborne austerity package, but that's for another day.
A note of caution regarding charts and chartists. What do you think the chartist view was in September 2008, just before sterling fell over the cliff?

So what now?

I have been forced to re-think my entire view of sterling's likely performance pre-Christmas. Somewhat reluctantly I think we may now indeed see an assault on the 1.200 level, so let's go for 1.2025 by the end of next week.

a bientot, Rob

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