The pound continued to make gains against the euro as the euro zone sovereign debt crisis continued to rumble with Irish, Portuguese and Spanish borrowing costs reaching record levels in the bond markets. This despite some negative sentiment about the months ahead for the UK economy.
In testimony to the Treasury Select Committee, Adam Posen, a member of the Bank of England’s Monetary Policy Committee (MPC) said that he was concerned about the support given by the MPC for the government’s plans to cut the budget deficit as this may be viewed as impacting on the MPC’s impartiality. The Bank’s governor Mervyn King expressed his backing for the new government’s deficit reduction plan in May.
According to the CBI, UK retail sales rose in November but retailers are concerned about the 2011 outlook. The share of companies reporting better business rose to 43% this month, up from 36% in October. But only 11% expected sales to improve next year, down from 22% in October. The CBI said one factor weighing on expectations for the new year is the VAT rise from 17.5% to 20%, which becomes effective from 1 January. Economists believe this will cause consumers to bring purchases forward to beat the tax rise, buoying sales in the Christmas period but depressing them in the new year.
In a joint statement, Germany’s Chancellor Angela Merkel and French President Nicolas Sarkozy have vowed to implement a permanent bail out facility amid speculation over a break up of the 16 nation eurozone. The two said that they would propose replacing the existing fund that expires in 2013. Meanwhile Axel Webber, head of Germany’s central bank said the existing fund could be increased if needed and dismissed the risk of a eurozone breakup.
As if to underline the ‘two speed’ euro zone at the moment, whilst the peripheral countries like Ireland, Portugal and Spain continue embroiled in a sovereign debt crisis, Germany’s economy minister Rainer Bruederle has given an upbeat assessment of his country’s recovery asserting that “full employment will soon be possible”. He added that Germans were “doing well and spending again” and that domestic consumption was strong. Data released this week showed German business confidence at a 20 year high. The euro has fallen by more than three cents against the dollar this week on fears that the Irish debt crisis may spread to other European countries with high budget deficits such as Portugal and Spain.
In a statement that is almost designed to increase risk aversion in the markets and see a flight to safety, thereby strengthening the likes of the US dollar, Japanese Yen and Swiss France, North Korea said on Friday that impending military exercises by the South and the United States were pushing the region toward war, days after it launched its heaviest bombardment since the 1950-53 Korean War.
The aggressive language is typical of North Korean state owned media, but the heightened tension was enough to depress the South Korean won by as much as 2.2% in the Asian markets overnight.
The United States is sending in an aircraft carrier group led by the nuclear powered USS George Washington to the Yellow Sea for the military exercises with South Korea starting on Sunday. Planned before this week’s attack, the four day maneuvers are a show of strength which, besides enraging North Korea, have already unsettled China, its neighbor and major ally. Washington is pressing China to rein in its ally North Korea to help ease tension in the world’s fastest growing economic region.
In the short term, the euro is likely to remain under pressure until the markets are convinced that a long term solution has been found for the problem economies and/or the economic situation deterioates in the UK, something most analysts are convinced will happen in the first half of 2011.
Meanwhile, the US dollar is likely to continue to strengthen amidst the rising political and economic tensions in the euro zone and Korean penisula.
