Royal Alliance Capital Currency Review

Euro zone debt costs shake markets

Global markets remained on edge last week as borrowing costs for both Spanish and Italian governments spiraled.

Declines started on Tuesday as yields for Italy’s 10-year bond rose to 7.07%; widely seen as unsustainable by market commentators, forcing the euro to mid-week lows of 1.3440 against the US dollar. Spanish bonds soon followed suit as the cost to service the latest bond auction has increased by half a billion euros in four weeks. However, speculation the European Central Bank will increase purchases of peripheral euro zone government bonds helped the euro pare some losses towards the end of the week.

European economic data had a muted effect on the euro as investors concentrated on the wider problems facing the peripheral economies. Industrial production dropped by 2% in September; its first fall in three months, whilst the euro zone’s economy grew by 0.2% in the third quarter.

The pound managed intra-week highs of 1.1730 against the euro, however, it pared gains towards the end of the week as economic data remained mixed.

The rate of unemployment rose to 8.3% during the third quarter of this year, whilst retail sales data was stronger-than-expected with a 0.6%

increase in September. The Bank of England (BoE) cut its UK growth forecasts on Wednesday, warning the absence of a credible solution to the current problems in Europe poses the biggest single risk to UK growth. The UK’s economy is exposed due to its close banking ties and its reliance on exports to the euro zone.

Whilst at times susceptible to investor’s risk appetite, the US dollar was again able to maintain its initial gains versus both the euro and sterling. Economic data showed signs of improvement as fears over a US recession eased providing a stronger footing for the dollar. US retail sales were up 0.5% in October, better than the flat result expected by a consensus. Industrial production also rose in October maintaining a more encouraging outlook for the US economy as a whole. However, consumer inflation data showed declines in its latest release, prompting Federal Reserve Governor William Dudley, to state that the Reserve could take additional measures if there was any renewed economic deterioration.

The Japanese yen gained against both the pound and US dollar last week as the Bank of Japan kept its current monetary policy unchanged in Wednesday’s meeting. Continued stock market losses throughout the week prompted currencies such as the Australian and New Zealand dollars to extend their recent declines versus sterling. These currencies tend to be highly sensitive to the global economic outlook and were hindered by developments in Europe. The Canadian dollar gained support after a higher-than-expected inflation reading in October, whilst better-than-expected retail sales data had a muted effect on the South African rand.

 

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