Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 13th of March.
Italy’s inconclusive elections are not, as the critics claim, the death knell for austerity politics in Europe. Italians understood the gravity of their economic situation when technocrat Prime Minister Mario Monti was parachuted from Brussels and the Italians were prepared to make the sacrifices. Unfortunately the political leadership wasted the opportunity and chose the easier path of austerity with higher taxes, leading to the present deadlock.
Austerity through tax hikes can be harmful while austerity based on appropriate spending cuts seems to be the best way to reduce a country’s debt burden. This is particularly true in the case of highly regulated economies where government spending accounts for nearly half of its GDP, as in the case of Rome. While history will apportion the blame for Italy’s sorry state of affairs, Mario Monti and his coalition partners must share the blame for the current deadlock.
Monti first raised the tax burden on its workers. Tax revenues added another 2.5 percent of GDP, taking the total to 45 percent. True, some of those measures were already there when Monti assumed office, but rather than scrapping them, he simply chose to carry on with them. Considering the rampant tax-evasion in Italy, which conservative estimates put at 15 percent of GDP, those who actually pay taxes were squeezed further.
Furthermore, the actual spending cuts proposed in the budget have been minuscule, barring the good pension reforms. Typically, cuts in budgets presented in parliaments entail reduction in transfer from the central to the local governments. The real cuts approved by the Monti government varied between EUR 1 and 8 billions, representing less than one percent of the $790 billion budget. Also, it remains to be seen if these cuts are implemented at all.
The developments are unfortunate if one considers the recommendations of a government appointed commission that suggested cuts in corporate subsidies and reduction of taxation on labor costs for firms. The suggestions were ignored, possibly due to paucity of time. But one of the direct outcomes of ignoring the recommendations is the increasing labour costs in Italy. This puts Italian firms at a disadvantage, particularly when the cost of hiring is falling in Greece and Spain.
The Italian economy is suffering not because of savage spending cuts since the cuts have been overwhelmed by tax increases. In reality, the Italian experience is consistent with the findings of a growing body of academic evidence on this subject; fiscal consolidation driven by tax hikes is a recipe for failure because it fails to stabilise debts and cause more economic contractions. Italy’s GDP shrank by 2.2 percent in 2012 and is unlikely to return to growth this year. By contrast, spending cut based fiscal consolidation along with supply-side reforms is likely to have positive effect on economic growth.
Unfortunately for Italians, Monti went the wrong way in search of austerity.
CURRENCY RATES OVERVIEW
GBP/EURO – 1.1442
GBP/US$ – 1.4944
GBP/CHF – 1.4116
GBP/CAN$ – 1.5342
GBP/AUS$ – 1.4472
GBP/ZAR – 13.6541
GBP/JPY – 142.89
GBP/HKD – 11.5914
GBP/NZD – 1.8086
GBP/SEK – 9.4724
EUR: The shared-currency had a busy day yesterday, swinging in both directions against most of its trading rivals. It peaked at 1.1370 against sterling and enjoyed a brief spike to 1.3070 against the US dollar. The common currency eased versus the greenback towards the end of the day after German finance minister said Cyprus would not be granted a bailout until it agrees to some form of bank restructuring. EUR/USD lost further ground after ECB member and Bundesbank President Jens Weidman said the eurozone crisis was not over and the German central bank has set aside the billions of euros in provisions due to the risky bond buying plan proposed by the European Central Bank. Sterling continued to weaken against the common-currency following the shock manufacturing and industrial production data from the UK yesterday. The GBP/EUR pair however trimmed losses overnight and is trading at 1.1468. Today sees the release of January industrial production data for the eurozone and markets expect production to shrink by 0.1 percent following December’s improvement of 0.7 percent.
USD: The US dollar had a mixed day yesterday, firming against the British pound after poor industrial data sent the cable tumbling over fears of another recession in the UK which pushed the US currency to a 2 ½ year high versus the pound. Sterling slumped to an intra-day low of $1.4830 after data showed manufacturing fell by 1.5 percent in January against expectations for a flat reading whilst industrial production tumbled 1.2 percent versus expectations for a 0.1 percent decline. However, the GBP/USD pair clawed its way back higher on profit taking by brokers to end trading in London back up around 1.49. Sterling came under further pressure after a GDP estimate released by the National Institute of Economic and Social Research (NIESR) suggested the UK economy contracted by 0.1 percent in February. The US unit however, eased up against the Euro with the USD/EUR pair trading at 1.3027 from 1.3037 on Monday. The ICE-dollar index, which measures the dollar’s strength against a basket of six global currencies, fell to 82.585 from 82.601 on Monday. There’s no data from the UK today and the GBP/USD pair opens at 1.4955 this morning. US retail sales data, expected to bring positive news, will be in focus for markets later in the day.
Have a great day!
