Foreign Exchange

Phil McHugh from currencies direct

Arguably, the policy interventions of late 2008 and 2009 resulted in a far briefer and shallower recession than most imagined possible. So the big questions for this year are how quickly to withdraw the monetary and fiscal stimulus and which should be withdrawn first? Remove QE too early we run the risk of a double dip recession. This is a scenario that could happen if growth over this quarter is less than the meager improvements made over the last 3 months. If QE is withdrawn too slowly then forecasts and assessments of our economic health become distorted because the economy is relying on an artificial stimulus as opposed to institutional capital reserves.

Devaluing the pound and keeping it at a weaker level is a policy that benefits producers and manufacturers. The weak pound has prompted the quickest margin of growth in manufacturing for 15 years, which in turn has resulted in a fractional rally in sterling over the last quarter. Although manufacturing activity grew by 0.3%, activity in Britain's dominant services sector slowed more than expected last month as the worst snowfall in 50 years paralysed the country.

Arguably the next most important date is the 15th of March because this is when the Treasury's Inflation Report hearings are scheduled. During these hearings the BOE Governor and several MPC members testify on inflation and the economic outlook before the Parliament's Treasury Committee. The hearings, a few hours in length, can create market volatility for their duration. Especially noted are the direct comments made about the currency markets; BOE MPC members vote on where to set the nation's key interest rates and their public engagements often drop clues regarding future monetary policy, such as Quantative Easing.

If the MPC's comments are more 'hawkish' than expected we may expect a positive improvement in the value of sterling. Hawks carefully monitor and control economic inflation through interestrate adjustments and monetary-policy controls. In general, hawkish investors prefer higher interest rates in order to maintain reduced inflation. With inflation over 1% above the 2% target, the hawks will vie for an increase in interest rates if consumer spending remains low, potentially stimulating investment and lending in the UK but stunting domestic borrowing and tighten up the property market.

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

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