Moneycorp: Euro Weekly Update
May 13th, 2009
Sterling hurt by renewed gilt buy-backs; Monetary policy continues to relax; UK purchasing managers are more upbeat than most; US banks are not going bust just yet; Euro rates are lower and the ECB is buying Covered Bonds.
A game of two halves saw sterling climb to €1.14 on Wednesday before slumping to €1.12 the following day. Consolidation on Thursday was not solid enough to prevent a further fall to €1.1150 at the end of the week and that was where the pound was changing hands when London opened this morning.
For financial markets in general the week was typified by a further relaxation of monetary policy and an improvement in investor sentiment. Although it was not a matter of cause and effect the two did go hand in hand. Central banks in Norway, Iceland, the Czech republic, Britain and Euroland were among those who either lowered policy interest rates or extended the scope of their quantitative easing.
Equity markets were mostly upbeat, a mood underwritten by the results of the “stress tests” that the US Treasury had insisted be undertaken by America’s biggest banks.
Hard economic data were relatively few and far between, even from those economies that usually churn them out by the dozen. In Britain’s case the two that mattered were came from the Nationwide building society and the Chartered Institute of Purchasing and Supply.
Nationwide reported a rise in its index of consumer confidence. The April reading went up from 42 to 50, the largest monthly rise in nearly two years. It did not exactly represent an outburst of exuberance among consumers: The index would have to almost double from its present level before the nation could be labelled “optimistic” but it was a worthwhile improvement nevertheless.
The CIPS’s services sector Purchasing Managers’ Index, similarly, was not good enough to be described as positive but it was better than most of the opposition. The headline figure went up three points to 48.7, eclipsing comparable measures from the United States (43.7), Germany (43.8), France (46.5), Italy (42.0) and the Euro zone as a whole (43.8).
One should not get carried away with a figure that is still negative – below the 50.0 breakeven level – but it is clear that things are getting worse much more slowly.
The Bank of England’s decision to dip into its kitty to buy more gilts was not helpful to the pound. The government initially approved a pot of £150 billion for the Bank to spend on supporting the gilt market.
The first £75 billion will be exhausted next month. When the Bank let it be known that it would spend a further £50 billion on buying gilts the market did not like the idea. The background suspicion is that the gilts bought by the Old Lady will never again see the light of day; in other words, that the government is printing money to lend to itself.
As suggested above, the Euro zone services sector PMI was slightly less soggy than the month before but not up to speed with Britain. Similarly with retail sales, Euroland’s decline in March fell short of the UK experience.
Thursday’s monthly council meeting at the European Central Bank produced a 25 basis point interest rate cut that lowered the refinancing rate to 1.0%. It also brought an asset purchase plan – quantitative easing – not entirely dissimilar to the one that the Bank of England is running.
The difference is that the ECB will not be purchasing its own debt. It will be buying €60 billion of “covered bonds” to replenish the supply of credit to end users, the corporates themselves.
Investors preferred the ECB scheme – and the euro – for two reasons. First, the ECB committed itself to the sort of decisive stimulus that was previously lacking. Second, there is no direct implication that it is printing money.
At first sight “covered bonds” might appear to have many of the characteristics of the disgraced mortgage bonds that brought financial markets to their knees in the United States: they are secured by a pool of mortgages and typically carry a AAA credit rating.
However, the paper that the ECB intends to buy is not junk cobbled together by cunning financial engineers; it is proper stuff, regulated to within an inch of its life by the supranational European Covered Bond Council in Brussels.
There is also a liquid market. With more than €2 trillion (billion) in circulation the ECB’s €60 billion (milliard) should not have a measurable effect on the market other than to raise the general price level and, presumably, to encourage new issuance; exactly what the ECB is trying to achieve.
Sterling is still in the €1.05-€1.15 groove. Never mind if you missed last week’s shot at €1.14, it will come again. Buyers of the euro should hedge 50% of their exposure and await another spike to increase their cover.
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