Foreign Exchange

Phil McHugh from currencies direct

Is this the sign of a prolonged re- covery both for the pound and the UK economy? Or will it tire, stutter and ultimately lag again later in the year? First let us look at why the pound has gained ground, against the euro in particular. The first thing that is clearly evident is that so far in January 2010 the GBP/EUR gains can be attributed to both a strengthening in the pound and a definitive weakening in the euro.

Looking at the gains in the pound we were helped by the National Institute of Economic and Social Research (NIESR) estimating that UK fourth quarter GDP, which is due out next week, will come in at +0.3%. This means that the UK will officially be out of recession! The upbeat assessment was mirrored by MPC member Sentence who commented that the Bank of England may need to raise interest rates this year.

No nasty surprises in the Bank of England minutes either, as the vote for January was a unanimous 9-0 to keep UK interest rates on hold along with Quantitative Easing. The markets are now awaiting the GDP levels at the end of January which will identify if the UK has exited the recession… The markets have responded well to the positive feedback from the UK economy and sterling has largely gained. Although this is mostly against the under pressure euro, which is having a torrid run! The economic “Greek tragedy” was definitely the catalyst for a sell off in the euro, however a return in the markets to risk aversion has not helped the euro.

Concerns are increasing on the maintainability of the ever expanding growth in China and fears are growing that China will act further to slow their rampant growth by raising rates. The euro was heavily bought into in 2009 as a leverage and diversification away from USD into assets with higher yields and commodities and this trend has to some extent unwound, weakening the euro. GBP/EUR is hovering around the 1.15 level: a further fall in EUR/USD would lead it cleanly through the 1.15 level. The markets will need to see a break under 1.40 on EUR/USD to underline the bearish tone on the euro. One thing’s for sure: 2010 is again going to be full of surprises and volatili- ty in the currency markets. For now the euro has the wooden spoon...

Please feel free to contact me at: phil.m@currenciesdirect.com and I will endevour to answer your questions.

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