Currency Update – Tuesday 6th January

Currency Update – Tuesday 6th January

Already this year things are looking up for the Pound especially against the Euro, as comments from the  ECB vice president, whilst in America, that Euro rates may have to be cut to make sure inflation doesn't fall to far, has weakened the Euro; his fear of deflation comes after both Spain and Italy announced inflation falling by more than expected in their respective countries. The vice presidents speech was out of line with previous noises coming out of the ECB, which seemed to suggest that rates would stay on hold, however with bad economic data recently out of the Eurozone countries, Germany could be heading for a recession as bad as the UK, inflation isn't the only reason for the ECB to cut rates. The comments have weakened the Euro which fell over 4c against the Dollar, and has allowed Sterling to climb back above 1.09, after starting the week at 1.04 against the single currency.

Sterling's climb against the Euro hasn't all been due to the single currency's fall, Sterling has benefited itself from a rise in risk appetite caused by saviour elect Obama's proposed $1 trillion stimulus package, with rumours that it will contain a $300 billion tax cut to help placate the Republicans. The proposed package hasn't just helped Sterling, the Dollar has also been given a lift; although the Pound has managed to climb towards 1.47 against the Dollar, the US currency has risen against other currencies, climbing 1.1% against the Yen, and 2% against the Swiss franc. Although the package has increased optimism in the short term that the US will drag itself out of the recession first, and has helped the Dollar accordingly, the long term prospects of the package for the Dollar do not look so rosy; the US government have taken on such a large amount of debt that doubts will be raised over their ability to cover it, the government could be tempted to run inflation higher to help cope with the burden.

Sterling has also benefited from rumours that the UK government are thinking of guaranteeing asset backed securities in an attempt to encourage banks to lend. Even if the MPC do cut rates by 50bp this Thursday this will probably not be enough to start banks lending and the government are thinking about alternative ways to stimulate lending and borrowing. Interbank 3 month borrowing rates are still significantly higher than base rate, and the Government think it will take a raft of measures, probably including rate cuts, guaranteeing securities, as well as direct government spending, (Gordon Brown has said he will create 100,000 more jobs, which means even more civil servants) to get the economy back on track.

The economic data starts rolling off today, with service sector PMI released for both the Eurozone and the UK. The Eurozone survey unsurprisingly fell to a record low, with the UK measure expected to follow suite. It's a busy afternoon over in the US, with pending home sales, factory orders, and the minutes from the FOMC meeting to give the markets some direction. The minutes will be the major release, as they are from the meeting in which the US Fed cut rates to near zero; they will hopefully give some insight into the Feds thinking as well as hinting at the Fed's quantitative easing strategy.

With rumours of government action seemingly having more impact than current economic data, the trend from the beginning of the week is likely to continue, so Sterling could benefit from the speculation, at least until more concrete information about Gordon's plans for guaranteeing loans, and details of Obama's stimulus package are released.

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