Forex report: Fitch warns on British deficit

When the French exclaim that something is formidable, it generally means great and wondrous things. However, when a ratings agency uses the same word to depict the challenges facing your fiscal situation, it’s far less wondrous as investors long of the British pound fast learned today. Fitch ratings agency warned of Britain’s need for a stronger medium term strategy and laid it on the line for lawmakers that the degree of deficit reduction put in place at the time of the final Labour party budget in April is simply not fast-paced enough to bring the ballooning deficit back to earth. The pound fell against the dollar to $1.4373 before recovering but remains lower on the day at $1.4418.

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British pound – In the last fiscal year, Britain paid out £31 billion in interest to fund the nation’s budget deficit. The worsening deficit on account of the recent financial crisis means the interest cost on the mounting debt is likely to propel funding costs to £70 billion looking five years forward.

The warning from Fitch comes as freshly-minted Prime Minister David Cameron discusses spending changes with Chancellor George Osbourne. Already economists are waiting for details on some previously announced spending reductions of £6 billion but will have to wait until a hastily convened emergency budget meeting on June 22. Failure to kick-start the deficit reduction engine or setting off on too slow a path runs the risk of credit agencies downgrading Britain’s top-notch rating and further impacting the pound. Sterling lost ground to the single European currency to 82.77 pence this morning.

Euro – It seems unfair that the drubbing at the end of last week for the euro, inspired by the self-doubt over national finances by Hungarian officials, has left the single currency in turmoil while the Hungarian forint continues to rebound. It would seem that the official responsible for wearing his nation’s heart on his sleeve may have overstretched the point, which is why all traditional measures of risk aversion have subsequently settled down. The forint is making headway, bond yields continue to recover while the cost of insuring against bond default on its sovereign debt has also fallen. At the time of the comments ahead of the U.S. employment report on Friday the euro was trading above $1.2200 in comparison to where it stands today at $1.1934.

U.S. Dollar – The soothing of the stormy Hungarian situation is detracting from the performance of the greenback. It does, however, appear to be etching a nasty hallmark on the back of the euro. Overnight comments from Federal Reserve Chairman Ben Bernanke are widely sourced this morning. He notes that the U.S. economy is recovering at a “moderate” pace and says that the FOMC will raise interest rates before full employment occurs or inflation takes hold.

In terms of the former such a policy shift would be out of character with a policy-making record that shows how the Fed awaits a pick-up in employment before striking with monetary policy. His comments are crystallizing the contrasting policy challenges ahead of him and the ECB with investors predicting the latter will be served up no choice other than to maintain low rates for longer in light of limited growth potential.

Aussie dollar – Chairman Bernanke’s remarks about demand did help reload some confidence in commodities and served to lift some prices. That news was welcomed by commodity dollar bulls who lifted the Aussie to 81.89 U.S. cents. An earlier business confidence report from National Australia Bank declined, but owing to a regional rebound for stock prices, investors stood by a recently battered local dollar.

Canadian dollar – The Canadian dollar fared better too and rose to 94.91 U.S. cents as risk appetite felt a little more stable on Tuesday.

Japanese yen –Japan made official the appointment of Mr. Kan to the Prime Minister’s office and at the same time party officials named former finance deputy Noda as the Finance Minister. It will be his job now to rally support for spending cuts in order to rein in a budget deficit that Mr. Noda recently warned might spark surging bond yields if lawmakers continued to pass stimulus spending measures. The yen weakened against the dollar to ¥91.69 per dollar and lost out in early morning trading to the euro, which added to ¥109.42, while the yen gained against the pound to stand at ¥132.17.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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