Can Sterling Find Its Silver Lining?

 Gordon Brown celebrated, if that’s the correct word, 1 year in the job on Friday. A worse year does not seem possible with one Sunday paper calling the past 12 months Indiana Brown and the Premiership of Doom. The economy is in freefall, the housing market is in the toilet and inflation is really starting to bite; your author seeing a loaf of bread for the princely sum of £1.80 in Sainsbury’s this weekend. Combine this with news from the financial sector that jobs will have to be cut, profits will fall and it looks like UK PLC is due for a shareholders revolt.

The first half of 2008 has been a pretty rocky one. We have seen more record price highs and more record economic reading lows in the past 6 months than I can remember.  Oil is now nudging $143 a barrel, gold is predicted to make another run at $1000 /oz and the Dow Jones as of this Friday is a few index points from officially entering a bear market. But what about sterling?

The pound is down 7.2% against the euro over the 1st half of the year but the picture has changed remarkably since then. In January we were still dealing with the fallout from the Northern Rock crisis while European banks were carrying on swimmingly, retail sales figures from the UK were down dramatically as mortgages choked Joe Public’s coffers while Herr und Frau Normal continued to enjoy an economy on the up. Now we have European banks admitting larger and larger write downs; Credit Agricole, Fortis and Unicredit to name but a few. The inflation picture is also starting to hurt Europe’s strongest economy, Germany, as recent falls on business and consumer sentiment indices have shown.

The story is a little better against the dollar although the cross has not declined to the extent that it would normally after a central bank cut rates by 3% in a period of 9 months. Dollar bulls are starting to be priced out of positions as the cross heads towards a rate of 2.00 and simple technical analysis does suggest that more upside may be realised. Event risk is to be minded however as was shown in last night’s appalling consumer confidence survey from the UK.

The next 6 months will certainly be as rocky as the last. The storm clouds continue to hover on the horizon but silver linings can and will show themselves. 

The week ahead 

It’s a short week for US data given the Independence Day holiday on Friday however this does nothing but squeeze more data into the remaining period. Normally Friday would see a Non-Farms Payrolls figure, this will now be released on Thursday, and although opinion is split as to the final reading, we foresee a deterioration of the situation. A precursor will be seen in Wednesday’s ADP release.

Apart from the ECB announcement on Thursday, a 25bps hike being World First’s view, we expect all data from the Eurozone to continue to emphasise current economic trends i.e. slowing growth and rising inflation pressures.  

Currency Rates                     Low                 High                Current  

GBPEUR                                1.2576            1.2671             1.2640 

As you can see from the figures above GBP/EUR has traded within a cent range over the past 7 days; a welcome respite to some from the volatility that has typified GBP crosses over the past 3 months. 

The data from the Eurozone was poor for the most part. PMI data showed signs of contraction, the indices reading below 50.0, in both the manufacturing and services sector with the services element hitting a 5 year low. The prominent German IFO survey also posted a 3 year low as it came out at 101.3.

We, and the market, however are pricing in a 25bps hike by the ECB on Thursday following the hawkish testimony from Trichet and this morning’s HICP figure which revealed inflation at 4%; double the prescriptive target set by the ECB. Should the hike go ahead we are certain to see increased political discord from those member states who are already in deep schtum.   

GBPUSD “Cable”                  1.9584              1.9949          1.9938  

Dollar weakened continually over the week to 2 month lows against GBP and close to the same against euro as it was affected by weak domestic data and strong upwards movements in Crude Oil markets.

Expectations of rate movement by the Fed were rife however were misplaced as Ben Bernanke’s bluff was called. The Fed held rates at 2.0% with only voter Fisher the member of the 10 man board proposing a hike. The accompanying statement was fairly downcast with warnings given over that state of the housing sector, unemployment market and the possibility of higher inflation. This has priced out a large proportion of the belief that we’ll see a hike in August; futures markets now put the probability at less than 25% against a 50/50 call this time last week.

Going forward we expect dollar to weaken but losses will be limited as investment inflows increase in the face of the continuing global slow down.  

Commodity currencies                                       

                                                  Low                 High                Current  

GBPAUD                                2.0546            2.0828            2.0696  

A private measure of Australian inflation jumped to new highs in June as households paid more for petrol and rents.    Automotive fuel jumped by about 25 percent in the year to June, while the cost of renting increased by over 14 percent. The TD Securities-Melbourne Institute monthly inflation gauge rose 0.5 percent in June, after a 0.3 percent increase in May.  Annual inflation accelerated to 4.8 percent, from 4.5 percent, the highest in the five-year history of the series.

Based on the inflation gauge for June, it is estimated that the government’s consumer price index (CPI) would rise by a hefty 1.28 percent in the second quarter. 

That would push the annual pace of inflation up to 4.3 percent, from an already high 4.2 percent in the first quarter.The Reserve Bank announces its interest rate decision on Tuesday and we expect no change to the current cash rate of 7.25%.     

Last week provided final confirmation of what the partial and confidence indicators had been telling us since the start of the year – that economic activity went backwards in the first quarter of 2008.  While the -0.3 percent outturn for the March quarter GDP was in line with both the market’s and the RBNZ’s expectation, there is nothing in the GDP report that gives us any comfort about the state of the economy going forward.  A July interest rate cut still looks dependant on the Q2 inflation figures, and the inflation stories remain problematic, particularly when you see international oil prices at US$140/bbl. 

Data released last week on the New Zealand front: Credit card spending (May) seasonally adjusted spending fell 1.1 percent, following a 4.4 percent rise in April.  The Westpac Consumer Confidence (June quarter) index fell from 96.5 in the March quarter to 81.7 in June – the lowest level since 1991.  Balance of Payments (March quarter) the annual current account deficit improved to 7.8 percent of GDP, from 7.9 percent of GDP in the December quarter. Given the near-term growth outlook, tumbling consumer confidence, troubles occurring in the finance company sector, we cannot rule out the RBNZ cutting interest rates in July.

Risk aversion is increasing as global credit concerns resurface and equity markets are back under pressure as the combination of credit and inflation worries see the earnings outlook for many companies downgraded.  The NZD should continue to trade with a heavy bias.  Further falls against the EUR, GBP and AUD are likely as markets contemplate interest rate hikes in those countries (with the ECB and RBA announcing decisions this week, with the former expected to hike)

This week a lack of local data is likely to mean that offshore sentiment will be the dominant driver of the NZD.  

GBPCAD                                1.9888            2.0206           2.0089

 Given the lack of dynamic conviction on FX markets CAD too traded sideways through last week. This was not helped by a dearth of data and speculators still surprised by the Bank of Canada’s call on interest rates last week.  Energy and commodity prices rose towards the end of the week which underpinned commodity currencies in general but provided little more than that.

CAD will continue to be volatile over coming weeks as it takes it cues more from energy markets and sentiment more than domestic data. As such parity levels against its US counterpart will be difficult to breach conclusively.

GBPZAR                                15.4827          15.8411          15.5937

The bleak outlook for the South African economy continues as oil price increases hammer the business and private population. The Minerals and Energy Department announced petrol price hikes of between 75c/l and 81c/l and diesel hikes of 68.4c/l.

This will obviously increase the pressure on consumers’ purse strings and as such market interest rate expectations continue to rise with an average prospect being a 50bps hike at the August MPC meeting.
Looking forward to this week we expect all data from South Africa to point to deteriorating economic conditions and weak consumer demand. Key releases include PMI and consumer confidence measures.