Royal Alliance Capital Currency Report

Euro gains on Greek debt deal hopes

The euro strengthened last week as markets continued to await news on a deal between Greece and its private creditors to reduce the country’s debt burden. The sterling/euro rate fell below €1.19 on Friday for the first time in 2012.

A weekend statement from the Institute of International Finance, which represents Greece’s private creditors, indicated a deal was close to being finalised and should be concluded this week. A deal is widely seen as a key condition for Athens to receive a second bailout package and help prevent a disorderly Greek debt default. Any agreement is expected to see Greece’s lenders write-off around 50% of the money owed to them, although reports suggest the main obstacle has been over the interest rate Greece will then be required to pay on its remaining debts.

If the euro is going to survive in its current form, many suspect the euro zone will eventually have to move towards a closer fiscal union, with coordinated tax and spending policies. No doubt creditor nations, such as Germany, would want greater control over debtor nations’ spending policies in return for footing most of the bill. Unsurprisingly, Greece strongly rejected a leaked German proposal on Friday for the European Union to have veto powers over Greek budget proposals.

UK economic announcements disappointed but were met with a muted response from the pound. A first estimate suggested the UK’s Gross Domestic Product (GDP) shrank by 0.2% in the final quarter of 2012, marking a sharp drop from a 0.6% expansion in the preceding quarter. Retail sales fell in January at their fastest rate since March 2009, dampening the economic prospects for the coming quarter and strengthening the case for further quantitative easing (QE) stimulus. The minutes of the Bank of England’s recent policy meeting confirmed policymakers were unanimous in leaving interest rates and QE unchanged earlier this month.

The US Federal Reserve left interest rates at 0-0.25%, expecting that a very low rate might be warranted ‘at least through late 2014’. This extended its previous timeline of at ‘least through mid-2013’, prompting the US dollar to drop markedly against the pound after the announcement. US GDP rose an annualised 2.8% in the fourth quarter according to an initial estimate. Although this was slightly lower than market expectations, it suggests the US recovery gathered momentum over the second half of 2012.

The Reserve Bank of India (RBI) kept interest rates at 8.5%, but lowered the cash reserve ratio (the level of deposits which banks need to hold with the RBI) in a move aimed at boosting bank lending and growth. The Indian Rupee ended the week 0.70% down versus sterling, with the closing GBP/INR exchange rate of 77.661 more than 5% lower than at the start of 2012.

The Bank of Japan kept interest rates at 0-0.1% and its asset-purchase programme at ¥20 trillion. It noted Japan’s recent economic activity has been more or less flat, mainly due to the effects of the slowdown in overseas economies and the appreciation of the Japanese yen (which makes domestic exporters less competitive internationally). The GBP/JPY closing exchange rate of 120.63 remains more than 13% lower than its 2011 high of 140.02.

Stronger commodity prices tended to help currencies such as the Canadian, Australian and New Zealand dollars relative to sterling. Canadian retail sales were slightly stronger than expected. A drop in Australian consumer price inflation was generally viewed as leaving the door open for the Reserve Bank of Australia to cut interest rates again, perhaps as soon as February. The Reserve Bank of New Zealand kept interest rates on hold at 2.5%, as had been widely expected.


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