Euro Weekly Update: June 24th 2009
June 24th, 2009
The pound managed to add a cent over the week but made heavy weather of it. Having risen to €1.1850 on Tuesday it was down almost to €1.16 by Thursday. It recovered quite easily and when London opened this morning it was back up to €1.1850.
Underlying sterling’s resilience last week was Tuesday’s Consumer Price Index figures. Inflation in Britain is proving to be much more stubborn than the analysts were expecting. They had been – have been – forecasting for months that price inflation would collapse to below zero as the recession tightened its grip. The Bank of England has been saying very much the same thing.
Yet it is still not happening. CPI went up by 0.6% in May and by 2.2% in the 12-month period. Inflation is still above its 2.0% target despite falling house prices, rising unemployment and a slowdown in earnings growth. Granted, it is three percentage points down from its peak in September but it is still the highest among G7 countries. Although there is currently no direct link between above-target inflation and rising interest rates it is hard for investors to ignore the tradition that says there should be. High inflation is better for sterling than low inflation.
Investors’ positive disposition towards sterling is not just because of inflation. Britain is managing to turn out economic data which are, in general, less negative than those of its peer group. That is why, on Thursday, they were taken aback when May retail sales were mush softer than expected. Instead of the forecast 0.5% monthly increase, what they got was a 0.6% fall that left sales 1.6% down on the year. The announcement was a setback to sterling but it was not long before it recovered the lost ground.
Investors, like inflation, can be stubborn. It has taken them months to pluck up the courage to buy sterling and they were not going to let it go just because of one bad retail sales figure. They proved that this morning when they totally ignored a downturn in the (admittedly slightly irrelevant) Rightmove index of residential property asking prices.
The euro got off to a bad start after the European Central Bank’s Financial Stability Report expressed concern about some of the banks under its supervision. It expects write-downs to continue and says “the credit cycle has not yet reached a trough.”
Looking at the broader economy the ECB said “Prospects for a significant turnaround in the short term are not promising.” By an unfortunate coincidence, credit ratings agency Moody’s announced on the same day that it had downgraded 25 Spanish banks and put UBS on downgrade review.
Some analysts worry that European banks have not put the same effort into rebuilding their capital base as has been happening in the States and Britain. They fear – as apparently does the ECB – that there are still sub-prime skeletons in many closets. The tone of the ECB report was that of a major finger-wag at Berlin and Paris where, according to critics, politicians are allowing banks to conceal the scale of their losses.
Euro zone inflation was very different from the UK situation. The headline annual rate remained stuck at zero after a tiny 0.1% price rise in May. Beyond the inflation data there was little useful new information out of Euroland. A 4.7% annual fall in construction out put was not a surprise; neither was a small shortfall in the April trade balance.
In sterling’s current mood it seems able – though maybe not without some effort – to push through every obstacle in its way. Last week’s dip almost to €1.16 suggests that level is the new support line. The next obvious obstacle is the psychological one at €1.20. Beyond that the more important technical resistance is the early December high in the region of €1.2150. Buyers of the euro should bide their time, using a stop order to protect against a reversal.
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