Tag Archive | "Bank Of England"

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Nervous Markets Await Fed and Employment


Nervous global markets anxiously await news from the US Federal Reserve and the new Labor Department unemployment data to be released on Friday. Improved data from Europe boosted European equity markets and raised the euro against the USD as the dollar regained footing against the yen.

Markets appear edgy about what Federal Reserve Chairman Ben Bernanke will announce regarding the possible tapering of the current stimulus. Most likely the news will be tempered at best. With unfavorable growth in GDP expected and with modest gains of about 185,000 new jobs expected, there simply is not enough impetus for the Fed to alter policy significantly, if at all. A gain of 185,000 jobs would trim unemployment to 7.5 percent, a step in the right direction but not a level likely to dissuade the Fed.

On Tuesday, US equities continued paring down but are poised to post record gains for the month. Eight of ten S&P 500 sectors declined for the day. All three major indices lost ground Tuesday. Yet, equities are ready to close the month with the sharpest gains since October, 2011. Early Wednesday trading indicated a rally in equities.

Also of interest to Wall Street is the successor to Chairman Bernanke. President Obama’s choice will likely influence markets with hawks boosting markets and selection of a dove bolstering the dollar.

The European Central Bank (ECB) is meeting this week and new forward guidance is expected from the ECB and from the Bank of England (BOE). The euro and the pound have strengthened in anticipation of new guidance and in response to encouraging data.

European equity markets closed flat for the day but the MSCI index of world stocks fell 0.5 percent.

Dollar Nervous

The dollar gained some strength overnight but slumped 0.5 percent against the yen on Tuesday to 97.93. Just last week, the dollar hit new highs against the yen. The dollar index briefly touched a five week low at 81.785.

Lee Hartman, a currency strategist with the bank of Tokyo explained; “The dollar faces a lot of key event risk in the week ahead with the release of the U.S. Q2 GDP report and the latest FOMC policy meeting on Wednesday, followed by the release of the U.S. employment report for July on Friday.”

The 10-year Treasury notes fell 3/32 with yields closing at 2.57 percent on Friday. Over the last two weeks, yields have ranged from a low of 2.l3 percent to a high of 2.63 percent, uncommon volatility. On July 8, 2013, yields hit 2.78 percent, a two-year high.

The German bund ended a comfortable bounce with a decline on Tuesday. Disappointing trade caused the decline.

Japan’s Nikkei touched a three-week low, sliding 3.3 percent. The stronger yen and poor data from Japan’s exporters hit equities unusually hard. The possibility of a new sales tax is weighing heavily on Japan’s economy.

Latin American Currencies

As the USD has strengthened and become more appealing to foreign investors seeking quality, Latin American currencies have suffered. As the Fed has considered tapering, Latin American currencies have fallen sharply over the past two weeks. A number of factors could continue to impact these currencies negatively in coming months.

Brazil’s industry index slumped to its lowest level in four years. The Brazilian real lost 0.4 percent on Tuesday on a sharp plunge in industry confidence.

  • The Mexican peso slid 0.6 percent to 12.7555 per USD, a two-week low.
  • The Chilean peso lost 0.7 percent to 511 USD, a one-month low.
  •  The Argentine peso shed 0.58 percent to 8.61 USD and has lost 21.25 percent this year.
  • The Mexican peso slid 0.6 percent to 12.7555 per USD, a two-week low
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Osborne Calls For Bolder BoE


Finance minister George Osborne stated his case for more aggressive and innovative Bank of England initiatives to help the country climb out of the economic rut that has led to a credit downgrade and has the economy on the verge of another recession. His address to Parliament was marred by jeers from Labor and their leader, Ed Millibrand.

While the politics is sticky, the current economic trends point to disaster unless a commitment to growth is in place. Osborne looks to the BoE to carry the ball by giving the economy some breathing room with an already stifling inflation rate.

Osborne made it clear that this was not the time to cut back on austerity. Prime Minister David Cameron and Osborne remain committed to the austerity strategy that is designed to narrow the deficit through curtailing public debt. Many Brits believe their success will determine the outcome of the elections in two years. The deficit reduction package is a five year plan.

Another EU Nation Long On Austerity, Short on Growth

However, as other EU nations have found, austerity without growth is a dangerous formula. Recession looms and the UK manufacturing output is discouraging.

Latest growth projections are dismal. Osborne announced the economy will grow about 0.6 percent this year. The finance minister projects 1.8 percent GDP expansion in 2014. He was quick to point out that the 1.8 percent would exceed the output of Germany and France.

Cameron and Osborne had paid a price politically for the struggling recovery. British sterling took another hit on Wednesday but the prospect of a more aggressive BoE seemed to stabilize equity markets.

Osborne called for the central bank to maintain its 2 percent inflation rate, if possible, but not at the expense of growth. He asked for the bank to devise a strategy to reduce the inflation rate over time if it became necessary to increase the rate by more than 2 percent to supply enough easing to stimulate growth.

Housing and Construction Must Lead Way

Of particular interest is the stagnant construction and housing industry. Osborne’s charge to the BoE would transform the mission to resemble the mandate of the US Federal Reserve, whose controversial three rounds of QE have sparked a slow, tenuous but steady recovery.  US equity markets have flourished in the meantime.

Most troubling in Osborne’s presentation is his paring of the 2013 GDP growth. The 0.6 percent is half the original 2013 projection of 1.2 percent.

Osborne said, “As we’ve seen over the last five years, low and stable inflation is a necessary but not sufficient condition for prosperity. The new remit explicitly tasks the MPB with setting out clearly the tradeoffs it has made in deciding how long it will be before inflation return to target.”

It looks like uneasy times are ahead for the Sterling and the UK economy.

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British Sterling In Jeopardy


US Equities looked to be turning down for the first time in over a week after European equities closed with modest gains. The euro shed 0.6 percent settling at 1.3035 as the dollar gave ground to the yen falling 0.27 percent to 96.01. Earlier in the session, the dollar had climbed to its highest rate against the yen since August 2009.

Oil continued to climb rising to $111 a barrel. US oil rose to $92.97 per barrel as crude rose by 5 cents to $110.27.

By noon EST, the Dow Jones Industrials Average was trending lower. The S&P 500 was off 4.13 points at 1,553.09. The Nasdaq was down 15.00 points to 3,237.87.

British Sterling Falls Further

The news from the UK was discouraging and plummeted the pound to 20 month lows with little hope of an immediate lifeline. Sterling fell to a 20-month low against the dollar to $1.4832.

The most damaging data came from the UK’s January manufacturing output. The decline marked the fasted downward spike since June 2012. Analysts expect the downward slide to continue as there is not economic data to suggest any strength.

Of late, sterling has suffered due to the nation’s credit downgrade and very low levels of economic growth. The UK is locked in many positions contrary to the members of the European Union and the natives are restless. The Bank of England has discussed the need for more quantitative easing which could sink the currency further.

The euro continued to rally against the pound reaching a two-week high at 88.77 pence, closing in on the 16-month high of 88.15 met on February 25. The BoE reported that losses against the dollar and the euro forced the sterling’s trade-weighted index to 77.9, a 20-month low.

Chief FX options strategist at Barclays Capital explained the dilemma facing the BoE. “If economic data continues to remain weak, like we saw today, it could make it easier for the BoE to loosen policy. Although our base case is for no more quantitative easing from the BoE just yet, it is a very finely balanced call.”

A serious problem for the Brits is that the spreads between the two-year US bond yields and the British two-year bonds are leaning toward the US, which, in turn, keeps demand for the dollar restrained. Market analysts observe that investors are selling sterling in favor of the dollar, not the euro. The US economic outlook is more stable that the euro.

2013 Performance Weak

The British pound has fallen 8.3 percent against the dollar and 7 percent against the euro. Sterling is the worst performing of the established currencies this year.

Minutes from BoE meetings indicate there is little reason to be optimistic about the economic trend of the UK. The most common opinion is that Chancellor George Osborne will give the BoE more latitude with inflation constraints, paving the way a period of quantitative easing and asset purchases.

The fear is that the Fitch ratings agency will follow Moody’s lead and also reduce the country’s credit rating. Neil Mellor, the Bank of New York’s currency strategist, said; “There are concerns on just about every front for the UK, political concerns, whether there will be another downgrade, the budget and whether or not we will see more monetary stimulus, everywhere you look there is a negative for sterling.” Expect more decline as the euro and dollar continue to stabilize.

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Positive PMI Report May Hold UK Recession Off


Taking a page from the US consumer, British consumers bucked current economic data and produced some unexpected PMI gains for February. The services sector, which constitutes three-fourths of UK GDP, grew at its fastest pace in five months and may well have lifted the onus of the country’s third recession in four years from the economy.

The country’s Purchasing Managers Index (PMI) rose in February to 51.8, surpassing January’s mark of 51.5 in January. The median economist PM forecast from analysts was 51.0. The report comes on the heels of the worst construction PMI in three years. After the economy shrank in the fourth quarter 2012, GDP seemed poised for another fall in the first three months of 2013. Those fears may be subsiding based on these stronger than expected numbers.

The Markit PMI report neither includes data regarding the retail sector nor data regarding the public sector. However, Markit reports that optimism about future business activity is strong, reaching a nine-month high at 67.6 up from 67.2 in January.

Inflation has cut into profits in the service sector but transport, storage, communication services, financial intermediation, business services, personal services, computing services, hotels and restaurants all reflect encouraging activity.

To add support to the PMI, the British Retail Consortium reported the best sales volume in more than two years. Most surprising is a boost in home sales. These purchase shave led to an increase in the sales of furniture, home goods and electrical goods.

The Bank of England

The dim construction report led to speculation that the Bank of England would resort to another round of quantitative easing, raising inflation concerns and devaluing the pound. Prior to the PMI report, Reuters analysts estimated there was a 40 percent chance of another easing initiative. The jury is still out on this verdict.

33 Percent of Brits Support Anti-EU Policy

In news that looks discouraging for Prime Minister David Cameron, a poll by YouGov indicates that there is growing support to pull out of the EU. Cameron has promised an up-down vote in 2017. Cameron’s Conservative Party appears to be losing ground to opponents of the EU treaty.

The YouGov poll suggests that Cameron waited too long to announce the long-awaited vote.  Liberal Democrats are poised to take a leadership role in Parliament and at the top. Led by Deputy Prime Minister David Clegg, Liberal Democrats received the biggest share of supp0ort in the YouGov poll.

Bonus Controversy

Recent EU legislation may well be the last straw for Britain and the EU.  Chancellor George Osborne has apparently failed in his efforts to block restraints on earning of bakers, investment bankers and risk takers. Although Germany asked a review of the new agreement which would limit the amount of bonuses bank leaders could capture, the majority of EU members states support the new controls.

Unlike in the US, the EU opposes commissions earned through risk taking that would require public bailout if the gamble failed. Commissions revealed in the wake of the 2008 meltdown offended the senses of most Europeans.

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Moody’s, Policy Shortfalls Sink Sterling


Moody’s fired a salvo across the bow of the British pound on Friday. The glaring policy inadequacies of the Cameron government started showing up in investor’s minds immediately. Given the sizable and aggressive quantitative easing initiatives and the lack of a sustainable recovery or an economically uplifting plan the country has endured since 2008, it is surprising that the downgrade and the fall of Sterling has not been more pronounced before now.

Here are some of the events following Friday’s downgrade of the country credit rating form AAA to Aa+

  • Sterling hit a two-year low against the USD on Monday.
  • The country appears to be facing another round of easing which will certainly sink Sterling further.
  • The pound has now fallen 7 percent against both the euro and the dollar in the first two months of 2013.
  • The euro has hit a 16-month high against Sterling.

The Bank of England may not be entirely displeased with a fall in Sterling as hopes for exports may improve. The central bank appears ready to follow Japan’s lead and enter into yet another round of easing. The plight of Sterling is more an issue of national pored than it is a negative for the economy.

In 2013, Sterling has lost 7 percent to the USD, while the euro has gained 7.5 percent against the British currency. Against the dollar, the pound is at $1.511, recovering from an intraday low of $1.5073, the lowest point since July 2010.

There is speculation that investors are investing heavily against the currency. Before the Moody’s credit rating downgrade, the Bank of England minutes indicated a move to another round of easing seems inevitable. The combination was too much for what has always been one of the world’s strongest currencies.

On Monday, Morgan Stanley released the following statement; “By moving the goal post of its 2 percent inflation target from two to three years, the BoE has reduced real rate expectations, markedly pushing the pound lower.

“Now rising inflation and pound weakness will pare living standards back down. We expect sterling to fall further and Friday’s rating downgrade was a marginal event in dictating the future path of the currency.”

It will be interesting to see how the credit rate reduction will affect government and business and the interaction between the two forces.

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BoE, ECB and The People’s Bank Act


In response to data suggesting a global slowdown, the Bank of England, the People’s Bank of China and the European Central Bank made conventional moves to attempt to breathe life into staggering markets.  The People’s Bank lowered its interest rate by 31 basis points to 6 percent.  The ECB trimmed rates to 0.75 percent, a historic low. The Bank of England left its interest rate at 0.50 percent but announced, the bank would begin another round of quantitative easing.

Britain is expected to print 50 billion pounds and use the funds to purchase distressed assets.  Previously, the Bank of England used quantitative easing to flood the market with 325 billion pounds.  Flooded with negative economic data, the ECB vowed to maintain their interest rate but stopped short of investing in upcoming bond markets or putting any cohesive remedies on the table.

ECB president Mario Draghi has continually stressed the need for a comprehensive overhaul of the euro zone debt crisis. Draghi appeared to be delivering a call to unified action to euro zone members. At this time, the ECB has no plans to revisit national bond markets.

Draghi’s frustration with the euro zone’s unwillingness to put a long-term program in place has come to a head.  On Thursday, Draghi told the media that new information pointed to deepening financial difficulties in the region. “We see now a weakening basically of growth in the whole of the euro zone including the country or the countries that had not experienced that before.”

Draghi emphasized that it is not just the southern tier of the euro zone that has economies fighting recession. The euro zone economies are no longer growing.  Most of the countries are either in recession or are headed there. Draghi appears to favor a combination of growth and more reasonable terms for floundering euro zone members.

The central banks of England and Europe were expected to act but China’s rate-cut surprised analysts.  The People’s Bank lowered rates last month, but in anticipation of next week’s data, the bank acted. It has been projected that China will suffer a six consecutive month of sliding growth.  It is believed that China’s second quarter will show the lowest growth since the collapse of Lehman Brothers.

Bank lending in China has experienced very little demand.  The interest rate decrease is intended to inspire businesses to grow.  The central bank previously lowered the reserve requirement ratio (RRR) to 20 percent.  This move freed more than 1.2 trillion yuan for new lending.  The bank is expected to lower the RRR to 19 percent before year’s end. However, analysts were quick to say that the central bank’s willingness to cut deposit and lending rates is more incentive than the RRR changes.

The People’s Bank launched a massive 4 trillion yuan spending bill in late 2009.  The spending policy has caused large volumes of bad debt that the country’s banks are struggling to retire.  However, it is believed that a continuation of poor economic data will spark some form of quantitative easing, which China has the resources to manage.

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Great Britain Not Waiting


Faced with a deepening recession and ever increasing unemployment, Great Britain is not waiting for the euro crisis and elections in Greece to deploy anti-recession tools.  Referring to the euro zone debt crisis as a “black cloud” which threatens the UK, Bank of England Governor Mervlyn King announced a plan to flood the country’s banks with low interest funds which the central bank hopes will be used to encourage borrowers and jobs.  King also said the Bank of England would activate an emergency liquidity tool.

Treasury officials revealed a separate plan that new funding would support up to 80 billion pounds in new loans. The Bank of England contributions will amount to 5 billion pounds per month for six-months.  King said the 110 billion pound injection should be used by businesses and civilians to “batten the hatches” before the crisis hits.

Finance Minister George Osborne supported echoed the global message that the euro zone put politics aside and solve the deepening crisis. Osborne stressed that the UK was not powerless to defend its economy or people.  Britain has not overcome the 2007-2008 recession that forced the Bank of England and Treasury to bailout the Nation’s banks.

Osborne has been criticized for implementing deep austerity cuts that have affected every walk of life in Britain. However, Osborne stated his case on Thursday saying that it was the austerity cuts that enabled the central bank to be able to assist in the current recession.  The austerity plan has come up a little short as the budget still runs at about a deficit equal to 8 percent of GDP.

Osborne and King have jointly developed strategies to spur growth, indicating that there is more assistance to come.  In the next few weeks, the BoE will be offering 3-4 year below current rate loans to the country’s banks. These loans will only be available to banks that have increased their lending to businesses and households.

The BoE will also commence using funds in the Extended Collateral Term Repo (ECTR) facility to help banks deal with liquidity issues caused by distressed loans. This facility was created in December for the specific purpose of offering banks six month relief from troubled loans.

In another area, King also hinted that there was a strong possibility of resuming quantitative easing, which was halted in May after the BoE had purchased 325 billion pounds in UK bonds.

While King emphasized the risk of the euro zone, he failed to mention that Britain’s economy is struggling with a new recession started in 2012. Britain’s Office for National Statistics reported that the trade deficit increased to 10.1 billion pounds in April 2012. This mark is the largest trade deficit since January 1988.  The biggest export gaps were recorded in the fields of chemicals and autos. Great Britain squeezed out a 0.1 percent growth 9in the first quarter of 2012 which appears to have been wiped out in the second quarter.

The Treasury and BoE moves have utilized the three weapons that Britain has moves available.  The first is the six-month liquidity loans issued by the Indexed Long-Term Repo (ILTR).  Through the Discount Window Facility (DWF) banks can swap stressed collateral for gilts for as long as one year.  The third tool is the Extended Collateral Term Repo facility which provides up to three years of financing for distressed assets which could come into play if Greece fails.

If Greece were to fail, the BoE has a large weapon, the UK Treasury’s Credit Guarantee Scheme, in reserve.  This plan was used to bailout banks to the tune of 250 billion pounds in 2008.  The majority of these funds have been repaid so this would be a stop gap available if Greece puts the nation’s banks under extreme pressure.

 

 

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Pound Stagnates, Lacking Direction


The British Pound has struggled to find direction in 2011. After getting off to a solid start – rising 4% against the US dollar in less than a month –  the Pound has since stagnated. At 1.625 GBP/USD, it is now at the same level that it was at five months ago. Given the paltry state of UK fundamentals, the fact that it still has any gains to hold on to is itself something of a miracle.


The Pound’s failure to make any additional headway shouldn’t come as a surprise. First of all, the Pound is not a safe haven currency. That means that the only chance it has to rise is when risk is “on.” Unfortunately, the Pound also scores pretty low in this regard. Annual GDP growth is currently a pathetic .5%, and is projected at only 1.8% for the entire year. Inflation is high, and both the trade balance and the current account balance are in deficit. Deficit spending has caused a surge in government debt, and there is a possibility that the UK could lose its AAA credit rating.

Investors might be willing to overlook all of this if interest rates were at an attractive level. Alas, at .5%, the Bank of England’s (BOE) benchmark rate is among the lowest in the world. Moreover, it isn’t expected to begin hiking rates for many months, and even then, the pace will be slow. Simply, the economy is too fragile to support a serious tightening of monetary policy. Interest rate futures reflect a consensus expectation that rates will be only 75 basis points higher one year from now.

If that’s the case, why hasn’t the Pound crashed entirely? To be fair, the Pound is losing groroundround against both the euro and the franc, the former of which has it bested in economic grounds while the latter is cashing in on its status as a safe haven currency. On the other hand, the Pound is still up for the year against the US dollar and Japanese Yen, both of which are also safe haven currencies.

It could be the case that the Pound is simply not the ugliest currency, since all of the charges that can be leveled against it can similarly be leveled against the dollar. Head-to-head, it’s actually quite possible that the Pound still wins, if only because its interest rates are slightly higher than the US. Or, it could be the case that investors still believe the BOE will come around and begin hiking rates. After all, at the beginning of the year (when by no coincidence, the Pound was still rising), expectations were that the BOE would have already hiked twice by this time, bringing the benchmark to a level that would make the Pound attractive to carry traders. While the BOE hasn’t followed through, carry traders may be sticking around, since the opportunity cost of holding the Pound is basically nil.

As for whether the Pound correction (that I first observed last month) will continue, that depends entirely on the BOE. Unfortunately, there is very little reason to believe that the UK economy will suddenly pick up, and hence very little reason to expect the BOE to suddenly tighten. At some point, earning .5% interest on Pounds will become unattractive to investors. Until that day comes, that might stick with the Pound out of sheer inertia. While the Pound may hold its value for this reason, I don’t think it has any hope of appreciating further this year.

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The Euro (Still) has a Greek Problem


Since the beginning of May, the euro has fallen by a whopping 7% against the dollar on the basis of renewed fiscal uncertainty in the peripheral eurozone. The optimists would have you believe that the markets will soon forget about the so-called sovereign debt crisis and just as quickly return their focus to monetary policy and other euro drivers. Personally, I think investors to follow such a course, as forex markets must eventually reckon with the seriousness of the eurozone’s fiscal troubles.

First, I want to at least acknowledge the primary sources of euro support. Namely, the European Central Bank (ECB) recently became the first “G4″ central bank to raise its benchmark interest rate; at 1.25%, it is now the highest among major currencies, save only the Australian dollar. Moreover, there is reason to believe that the ECB will hike further over the coming six – twelve months. First of all, eurozone price inflation continues to rise, and the ECB is notoriously hawkish when it comes to ensuring price stability. Second, Q1 GDP growth for the eurozone was a solid .8%, thanks to especially strong performances from France and Germany. While the ECB will likely follow the lead of the Bank of England and wait until Q2 data is released before making a decision, the strong Q1 performance is nonetheless an indication that the eurozone can withstand further rate hikes. Finally, Mario Draghi, who has been confirmed to replace Jean-Claude Trichet in June as head of the ECB, will need to effect an immediate rate hike if he is to establish credibility with the markets.

As I wrote in my last euro update (“Time to Short the Euro“), however, such a modest ECB interest rate – regardless of how it compares to other G4 rates – should hardly be enough to compensate yield-seekers for the risks associated with holding the euro for an extended period of time. Of course, the primary risk I am talking about is the possibility first of a full-fledged sovereign debt crisis, and secondarily of a eurozone banking crisis.

At this point, it is painfully obvious to everyone except for EU officials that the status quo cannot continue. Bailout funds cannot be expanded and rolled over indefinitely, especially since 3 countries (Greece, Ireland, and Portugal) are now involved. Greece, which is certainly the most pressing case, faces skyrocketing interest rates and declining interest from creditors, even as its budget deficit and national debt rise and its economy shrinks. Under these conditions, there is no way that it can re-enter private bond markets in 2012 (as was originally expected), if at all.

Thus, the only question is, what will happen instead? If Greece were to leave the eurozone, it could inflate away its debt, devalue its currency, and decrease interest rates. Regardless of its merit, this possibility has been vehemently dismissed because of concerns that it would lead to the implosion of the euro, and it seems very unlikely. What if Greece were to restructure its debt, by demanding concessions from bondholders? Based on the bond covenants, it apparently has wide latitude to do so, and might not even face legal repercussions. This possibility is also opposed by the ECB and EU officials because it would force banks to take massive [see chart below] write-downs on their debt holdings.

Greece could similarly elect to “re-profile”- basically lengthening the bond maturities (no “haircut” on interest and principal), ostensibly to give it more time to retool economically and fiscally. While this is a popular option, it probably would only succeed in forestalling the inevitable. Finally, the EU (with help from the IMF) could continue to loan money to Greece, in exchange for more additional austerity measures and collateralized by sales of state assets. Alas, this would be met with stiff political resistance from Greece. Not to mention that the recent indictment of Dominique Strauss-Khan – head of the IMF- on rape charges has jeopardized what has been the highest-profile advocate for continued support of Greece.

It seems inevitable that Greece will default on all or part of its debt. That’s not to say that this would cause its economy to collapse, nor that it would precipitate the end of the euro. In fact, recent history is full of cases of countries that successfully declared bankruptcy and emerged several years later unscathed. In this way, Greece could probably eliminate half of its debt, and significantly ease the burden that it poses.

Of course, this would not only set a dangerous precedent for Ireland, Portugal (and perhaps even Spain and Italy), but it would also reverberate throughout Europe’s banking sector, and would probably necessitate multiple bailouts. But what’s the alternative? Dragging out the crisis with secret meanings and feckless proposals will only add to the uncertainty. If Greece and the rest of the eurozone can come to grips with its collective fiscal problem, it will certainly cause chaos in the short-term and a further decline in the euro. By removing uncertainty, however, it will buttress the euro over the long-term and allow it to remain in existence.

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Pound Correction is Already Underway


Last week, I was preparing to write a post about how the British pound was overvalued and due for a correction, but was sidetracked by a series of interviews (the second of which – with Caxton FX – incidentally also hinted at this notion). Alas, the markets beat me to the bunch, and the pound has since fallen more than 3% against the dollar- the sharpest decline in more than six months. Moreover, I think there is a distinct possibility that the pound will continue to fall.

Not much has changed since the last time I wrote about the pound. If anything, the fundamentals have deteriorated. Fortunately, the latest GDP data showed that the UK avoided recession in the latest quarter, but this is offset by the fact that overall GDP remains the same as six months ago and still 4% below pre-recession levels. Despite a slight kick from the royal wedding in April, the UK will almost certainly finish 2011 towards the low end of OECD countries, perhaps above only Japan. Ed Balls, shadow chancellor of the UK, has conceded, “We’ve gone from the top end of the economic growth league table to being stuck at the bottom just above Greece and Portugal.”

Of course, the question on the minds of traders is whether the Bank of England (BOE) will raise interest rates. Initially, it was presumed (by me as well) that the BOE would be the first G4 central bank to hike, if only to contain high inflation. In fact, at the March monetary policy meeting, three members (out of nine) voted to do just that. However, there stance softened at the April meeting, and they have since been beaten to the bunch by the European Central Bank (ECB) which is notoriously more hawkish.

Now, it seems reasonable to wonder whether the BOE might also fall behind the Fed. While still high (4%), the British CPI rate has slowed in recent months. “The bank’s Governor Mervyn King said on Jan. 26 that rising prices would be temporary.” Moderating commodity prices have reduced the need for a rate hike, and bolstered the case for keeping the pound week. Unemployment is high, construction spending is falling, and the current account deficit remains wide. Moreover, budget cuts (declined to contain a national debt that has almost doubled in the last three years) and a a hike in the VAT rate have dampened the economy further, to the point that it might not be able to withstand even a slight rate hike.

Furthermore, record low Gilt (the British equivalent of the US Treasury bond) rates reflect expectations for continued low rates for the immediate future. If Q2 GDP growth – which won’t be released for another 3 months -is strong, the BOE might conceivably vote to tighten. Still, we probably won’t see more than one 25 basis point before 2012.

It seems that the only thing that kept the pound afloat so long was its correlation with the euro, which recently rose above $1.50. It has since fallen dramatically and dragged the pound down with it. In fact, the pound probably needs to fall another 3% just to stay on track with the euro. If this correlation were to break down, it would almost certainly fall much further.

It has become cliched to suggest that the forex markets have become a reverse beauty pageant, whereby investors vote not on the most attractive currencies, but rather on the least ugly. At this point, it is safe to say that among G4 currencies, the pound is the ugliest.

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