Currency Update – Tuesday 20th January

Trading was thin yesterday due to Martin Luther King day over in the US, and this may have exaggerated some of the currency moves, in what was a very volatile day. The renewed problems of the banking system has sent Sterling into a spiral, especially against the Dollar, as RBS announced their record loss as mentioned in yesterday’s note, and details emerged of just how uncertain the banks still are regarding the worth of the assets they hold. All this is in spite of the announcement of the Government’s 2nd attempt at a bail out plan, in fact it is partly due to it, as the government were not able to create a so called ‘toxic bank’ which would hold all the bad debts that the banks have, as the banks are not certain how much bad debt they have. Even the current bail out plan, to charge banks a fee to insure further losses on bad debts, will be problematic as it’s hard to determine the level of insurance premiums when it’s impossible to accurately measure the risk and the cost of default. The government also took a more direct hand in RBS exchanging their preference shares for ordinary shares and increasing their stake holding to 70%, as the share price tumbled 67%. The government could have bought RBS outright with the amount of money it has spent shoring the bank up.

The financial sector problems have sent Sterling crashing to a near seven year low, around 1.41, against the USD, as the dollar benefits from safe haven flows with the latest bought of worries test the resolve of nervous investors. This represents a huge fall from the start of the week, in which the Pound started up near 1.50 against the USD.  The Dollar has also rose against the Euro, forcing the currency pair down to below 1.30 as Standard & Poor downgraded Spain’s credit rating from AAA to AA-, the first time a triple A rated nation has been downgraded since Japan in 2001. Speculation has increased over further downgrades to other Eurozone nations, and with the European commission revising their expectations of GDP for 2009 down to 1.9%, the Euro has suffered.

With Sterling tumbling yesterday, it is only the weakness in the Eurozone which has stopped Sterling sliding by a similar amount against the Euro as it has against the Dollar, although it has still slid down to 1.0850, when it started the week at almost 1.13.

With it being Obama day over in the US, the economic news will be kept to a minimum, and the focus, at least in the UK, will be on our CPI figures. These are the first figures which will reflect the government’s cut of V.A.T and therefore they are expected to show prices falling and the CPI is forecast to drop from 4.1% to 2.4%, and will undoubtedly spark fears of deflation. The fall in inflation at least spares the Governor of the BoE having to write a further note to the Chancellor, although of course once the rate dips below 1% he will have to right a note explaining why inflation has fallen below it’s range.

Sterling looks likely to test 1.40 this morning against the Dollar, and it has already slid below 1.08 just in the time it’s taken to write this note.

Michael Corcoran – Assistant Manager  | Treasury Solutions