Currency Update – Monday 5th January

As the majority of the nation sleepily return to work for the first time this year, scraping ice and snow from their windscreens, the markets are neither cold nor lethargic, with Sterling already rallying more than 2c against the Euro. Over the Christmas period thin trading exaggerated moves for Sterling sending it to a new record low and nearer parity against the Euro, bottoming out just above 1.02, while the Pound also slipped against the Dollar, falling to a six and a half year low, down around 1.44. The Pound was not helped by bad news from a Nationwide House price survey which showed that house prices had fallen by over 14% in 2008; in other less than surprising news, mortgage approvals were still at low levels, and credit conditions remain tight. However it seems that the start of the year has brought some new found optimism, or at least the pessimism has shifted from Sterling to the Euro, with bad news on the Eurozone economy weakening the single currency and allowing Sterling to claw back some of it’s December losses, although only to around 1.06, while the Pound has managed to bounce back to hover around 1.45 against the Dollar.

The American’s can always be relied upon to be optimistic, and the news that Obama was meeting leaders of the House and Senate to ease a stimulus package through congress, which may be more than some expected (possibly as much as $1 trillion), has boosted the S&P500, which has jumped over 7% between Christmas and New Year; once again this jump is probably exaggerated by thin trading over the holiday period, but the optimistic tone has fed through to the commodity prices, with an index of industrial metals already up 10% this year. The rise in equities is even more remarkable as it came on the back of a manufacturing survey falling to a 28 year low, and Friday’s non-farm payroll figure is also expected to slump, showing a further 500k job losses over the last month. Many have derided Gordon Brown’s intention to use government spending and put the state into debt, to stimulate the economy (not least eh German’s who already have larger state debt than the UK), but it doesn’t seem to have effected Obama’s halo that he is planning a much more ambitious plan, and the US government already has a much larger public borrowing level.

The big event for the start of the new year, at least for the UK, is Thursday’s rate decision. The market’s expectation seems to be for at least a 50bp cut, which would take the rate down to an all time low, and in this case all time means 314 years. However there are calls for an even larger cut up to 100bp, these are not likely to be met, as Nationwide have already proven any further cuts are probably not going to be passed on by the lenders, and the BoE are likely to want to keep something in reserve if the economy takes an even sharper turn for the worse. The MPC may not even cut rates at all this month, after all this was the consensus up to only a couple of weeks ago, and the bank must be worried by Sterling falling perilously close to parity with the Euro. The Euro has benefited from short term investment flows as the ECB cut rates at a slower pace than the MPC and the US Fed, but as Euro interest rates continue to come down, the Euro will lose some of it’s lustre, and we could see Sterling claw itself away from the current historic lows we experienced in the past month, this move could be accelerated if the MPC defy market expectations and refuse to cut rates.