Forex report: British pound in the spotlight

Having been spooked by fears ahead of an austere budget that growth might be crimped by spending cuts, the British pound is heading for the $1.5000 mark, where it hasn’t traded for five weeks. The consensus appears to be that Chancellor Osbourne’s budget was tough enough to maintain the nation’s top credit rating without bruising the economy enough to tip it into a second recession. Icing the cake for sterling bulls today was the revelation that MPC member and known hawk Andrew Sentance put a rate rise on the agenda at the June 10 monetary policy meeting.

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British pound – The pound further divorced itself from the plight of a European banking crisis on Wednesday as dealers digested the budget and considered the prospect for an interest rate increase later in the year. The new coalition government’s effort to get fiscal policy back on track is seen to be sufficiently draconian to keep the wolves from the door without harming growth enough to create recessionary fears. Fitch ratings agency yesterday said that Britain’s “ambitious” plans were enough to maintain its credit rating. The pound was sunk several months ago as budget deficits were cast into the spotlight and several analysts pointed to Britain’s position coupled with political uncertainty stemming from what proved to be a very tightly contested general election. But the resultant Liberal-Conservative coalition has put the issue front and center and has delivered sufficiently tough measures, on paper at least, to boost confidence that the situation can be rectified during the current Parliament.

MPC member Sentance was recently quoted by a leading weekend newspaper outlining a scenario under which interest rates should be increased. In the minutes of the recent meeting released today he called for an interest rate increase explaining that inflation was proving to be resilient. At an ensuing address to bankers the City of London Bank Governor King appeared to downplay those comments by claiming that excess capacity would remain sufficient to bear down on inflation.

And so while the cat is out of the bag on an interest rate increase, we know who won the day at the recent meeting. But Mr. Sentance’s sentiment at least might bolster the pound for some time to come. The pound rallied to $1.4943 taking out Monday’s exuberant high in response to China’s revaluation. Unlike other currencies, the pound appears to be heading higher still.

U.S. Dollar – In a letter carried by Wednesday’s Wall Street Journal, Treasury officials Geithner and Summers warned G20 leaders to go easy on tightening their budgetary positions as they attempt to defuse sovereign debt worries in the aftermath of the Greek debacle. “Without growth now, deficits will rise further,” they warned. The letter also welcomes the weekend move by China in removing its dollar peg and said that it should continue to enforce the move with vigor.

The dollar index has turned lower midweek, not necessarily because risk appetite has resumed, rather because the lack of such appetite is sparing demand for the safety of the Japanese yen. The FOMC will make its policy announcements this afternoon and some investors expect a more downbeat assessment of the outlook for the U.S. economy. On Tuesday investors were disappointed by a 2.2% decline in existing home sales taking it as a sign of weakness for the economy. Later this morning we’ll see whether the amount of new home sales fell by the expected 19% in light of the end of a government tax incentive scheme.

Euro – The euro is flitting between gains and losses against the dollar after a report indicated that the pace of expansion in the Eurozone was increasing albeit at a lesser pace. PMI data for services and manufacturing sectors came in lower than last month but continued to indicate expansion. It seems like splitting hairs if you want to say that the Eurozone recovery is starting to come undone based on today’s report. The euro is trading at $1.2263 and is a little easier against a powerful yen at ¥110.65. Investors remain wary of the euro on account of recent reports raising concerns over the banking system. Today S&P warned that Spanish banks face a tough time this year and next as pressure on revenue generation is likely to follow mounting credit losses. French bank Credit Agricole wrote down more losses on exposure to a Greek holding while earlier in the week BNP Paribas faced a ratings downgrade by Fitch.

Aussie dollar – Fear that those European banks will hamper global growth and make riskier assets less appealing weighed on the Aussie dollar midweek. Having celebrated the removal of the dollar peg by the Chinese by trading as high as 88.59 U.S. cents, it has lost its impetus today and has receded to as low as 86.72 cents.

Canadian dollar – The Canadian dollar was also adversely impacted on Tuesday as limp U.S. housing data was interpreted as a weakening of the economy. Demand from the U.S. is a key catalyst for Canada’s economy. The Canadian dollar sank to 96.62 U.S. cents early on Wednesday having traded as high as 98.57 cents at the start of the week.

Japanese yen –The yen continues to garner favor with investors as uncertainty over the outlook for the global economy hovers overhead. Against the dollar the yen rose to ¥90.27 in early U.S. trading while it fell against the pound to ¥134.64.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC

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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