Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 27th of February.
In its sixth year now, the European crisis is ensnaring politicians into new interventionism that, as Prime Minister David Cameron has put it, may change the eurozone beyond recognition while violating the currency-zone’s economic and political rules. The latest demand for an ECB intervention to manipulate the currency by French President Francoise Hollande is an addition to the already long list of claims.
The cheap credit that flowed after the formation of the currency zone fed an inflationary bubble in Southern Europe, which burst when financial crisis hit. Credit terms worsened overnight and the region was left with devastated economies excessively dependent on foreign borrowing.
The French economy got battered for two reasons; one, its customers in the south turned insolvent and two, the country was not competitive enough. A Goldman Sachs report showed Paris needed internal devaluation of 20 percent relative to the European average and a whopping 35 percent against versus Germany to restore its external debt sustainability.
The IMF and the ECB have tried to ease the lack of private capital with public credit. The ECB put itself into peril by shifting its credit refinance and money creation, to the tune of EUR 900 billion, toward South and Ireland through lower collateral requirements for credit refinancing. To a large extent, the collaterals consisted of government bonds. Additionally, to stop the slide of these securities, the ECB bought the government bonds and assured to buy them in unlimited amounts if need be. The European Stability Mechanism was established simultaneously to safeguard the interest of struggling banks and states.
These steps strengthened confidence and resumed capital flows from the core to the peripheries. External capital from the rest of the world also started flowing as euro-denominated securities became attractive again, pushing up exchange rates and creating a new set of problems.
ECB President Mario Draghi rejected Hollande’s demand almost immediately since he’s well aware of the huge sums that were lost in the ‘70s and the ‘80s after the abolition of the Bretton Woods system in a futile attempt to stabilise exchange rates.
The ECB’s measures so far lays bare the collateral damage that the core countries have suffered. The currency appreciation put the taxpayers and the pensioners of the core at a great financial risk. It has also resulted in lower competitiveness for the entire currency bloc and hindered an internal depreciation. Lower prices for labour, goods and assets would have enabled the troubled peripheries to attract fresh private capital and regain competitiveness. In other words, the ECB’s rescue policy is making the recovery process more difficult.
CURRENCY RATES OVERVIEW
GBP/EURO – 1.1532
GBP/US$ – 1.5114
GBP/CHF – 1.4077
GBP/CAN$ – 1.5492
GBP/AUS$ – 1.4786
GBP/ZAR – 13.3356
GBP/JPY – 138.50
GBP/HKD – 11.7152
GBP/NZD – 1.8304
GBP/SEK – 9.7372
EUR: Political turbulence in Italy, the third largest eurozone economy, has taken its toll on the euro, pushing the shared-currency to a seven-week low against the dollar and erasing three cents against sterling. The political deadlock showed voters had favoured anti-austerity parties, sparking concern about the government’s ability to push through reforms in future aimed at reducing budget deficit. The damage was contained however, after S&P said Italy’s credit rating isn’t at immediate risk and we saw decent month end buying flows in the EUR/GBP pair over the past 24 hours. We have two key events today that may trigger volatility in the currency market. Firstly, Italy auctions 10-year bonds today morning and higher yields will indicate lower confidence in EZ’s third-largest economy. Secondly, the ECB President is due for a speech in Germany and typically his speeches cause wide fluctuations in the market. The GBP/EUR pair opens at 1.1547.
USD: The US dollar made gains against most of its rivals yesterday after Fed Chairman Ben Bernanke told the US Senate Committee on Banking that economic recovery in the US due to the central bank’s bond-purchase program has been sustained and somewhat uneven. Defending the Fed’s expansionary policies, he said inflation remains subdued and inflation expectations remain well anchored, indicating the Fed will not win down its $85 billion a month bond purchase program in a hurry. The ICE-dollar index, a gauge of the US currency’s strength against a basket of six global currencies, rose to 81.852 compared to 81.766 on Monday. US consumer confidence reading and new home sales data came in better than expected, increasing the allure of safer assets. GBP/USD pair fell to an overnight low of 1.5084 and opens marginally higher at 1.5102 in London today morning.
Have a great day!
