The pound fell against the euro for the second day in a row ahead of today’s interest rate and Quantitative Easing (QE) decisions from the Bank of England (BoE) and European Central Bank (ECB).
The pound came under pressure and fell against the large majority of the 16 most actively traded currencies after data from the Office for National Statistics (ONS) showed UK gross domestic product (GDP) increased by the slimmest of margins possible, just 0.1% in volume terms for the second quarter of 2011, a downward revision of 0.1% from the preliminary estimate and the slowest rate in two quarters. The consensus estimate was for a rise of 0.2% on quarter.
This increased speculation that at lunchtime today the BoE will announce an increase to the QE budget to stimulate the UK economy into growth. From a fx point of view, QE has to date been seen to devalue the pound.
The euro gained support, despite Tuesday’s downgrading of Italy by credit ratings agency Moody’s on fresh hopes that EU officials will strike an agreement to help soothe the long running euro zone sovereign debt crisis.
German Chancellor Angela Merkel sparked optimism after she indicated that the EFSF, its bailout fund could be used help stabilise the country’s own banks and banks in the rest of the euro zone system.
An announcement from a International Monetary Fund (IMF) official said it may buy Spanish and Italian bonds as well as using the EFSF helped sentiment towards the euro.
Sentiment was also lifted by better than expected US manufacturing and payrolls data. This led to an increase in risk appetite and help the high yielding currencies like the Australian dollar, New Zealand dollar and South African Rand recover some of their recent losses against the pound.
However, the upbeat mood was quickly tempered by the release of the Regional Economic Outlook from the IMF which projects that growth for all of Europe will slow from 2.3% in 2011 to 1.8% in 2012. Worth noting, the Washington based lender says that, “the projections are predicated on the assumption that strong action is taken to contain the current crisis.”
According to Antonio Borges, Director of the IMF’s European Department, European leaders must put emphasis on the speedy implementation of the new crisis management tools agreed upon at their July 21 summit and design a comprehensive plan.
An interesting foot note to the report was the implication that the ECB should ease interest rates further as “risks to growth and financial stability persist and inflationary expectations remain well anchored.”
In a note to clients, economists at Barclays Capital recommended their clients go ‘short’ into today’s interest rate announcement by the ECB and press conference by the ECB President, Jean Claude Trichet.
Simply put, they expect the ECB to adopt both conventional and unconventional measures to address market stress and for the Euro to react by falling. Those measures are:
1. Offer supplementary LTROs (long-term refinancing operations), including of six or twelve months’ maturity;
2. Stick with the same parameters for purchasing Italian and Spanish debt;
3. Re-open the covered bond purchase programme;
4. Widen the interest rate corridor; and
5. Lower the main policy rate.
This could lead to a further sell off in the euro as a combination of some or all of these measures could cut the interest rate differential between the euro and other currencies.
