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March 21, 2012 Leave a comment

Euro zone debt doubts linger

Markets were reluctant to look favorably on the euro last week despite euro zone leaders reaching a long-delayed second Greek bailout.

Whilst the deal provides some breathing space, doubts linger as to whether the country will successfully implement the austerity cuts needed to put its debts on a sustainable footing. Adding to concerns, Spain raised its 2012 budget deficit target after recently confirming it would fail to meet more ambitious plans to control public spending.

Although sterling maintained its initial gains against the euro to finish the week at €1.2014, this remains a short distance below its 2012 high of €1.2162 reached in early January. The pound managed to shrug off later disappointment that the jobless rate stayed at a 16-year high of 8.4% in January. Ratings agency Fitch warned the UK might lose its AAA debt rating in the next two years, which could make George Osborne more determined to press ahead with the government’s deficit reduction efforts in this week’s Budget.

The US dollar also lost ground versus sterling, despite a continuing run of encouraging US data. The US Federal Reserve left interest rates at 0-0.25%, but dampened expectations that the central bank might need to re-deploy its quantitative easing (QE) measures in the near-term. A relatively upbeat accompanying statement noted the recent improvement in

employment prospects and described the economy as expanding moderately. A reduced likelihood of QE was viewed positively for the US dollar and negatively for gold, which was sold off sharply after the statement.

The drop in gold prices, along with surprisingly weak domestic retail sales, led the South African rand to fall almost 2% versus sterling on Wednesday. However, the rand has been one of the strongest performing currencies recently, having gained almost 5% against sterling since the start of 2012.

Other commodity-bloc currencies such as the Australian and New Zealand dollars have also enjoyed bright starts to the year. Without major domestic influences last week, both currencies lost a little altitude against the pound as commodity prices weakened. The Canadian dollar has typically lagged other resource-led currencies in recent months and did so again last week. Whilst Canadian households increased their net worth in the final quarter of 2011 as asset values rose, the Bank of Canada recently singled out mounting household debt as the biggest domestic risk to the economy.

The Japanese yen remains by some distance the worst performing major currency so far this year, having lost over 10% of its value versus sterling. The domestic consumer confidence index dipped slightly to 39.5 in February, where any reading below 50 indicates greater pessimism than optimism amongst households.

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