Good morning and welcome to today’s foreign exchange market commentary on Tuesday, the 22nd of January.
The European fiscal compact, technically known as the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, came into force at the start of 2013 after its ratification by Finland. The treaty requires members to introduce new laws to limit their structural budget deficits to 0.5 percent of GDP or less than one percent if debt/GDP ratio is below 60 percent. This will allow country’s to run deficits above the target only if the difference between revenue and spending is due to business cycles, i.e. the targets are cyclically adjusted. This rule is expected to be enshrined in national constituencies by the end of 2013.
The aim is to fix the long-term fiscal situation which deteriorated mainly due to three reasons; the failure of the Stability of and Growth Pact (SGP) that was meant to enforce the deficit and debt limits; the crisis that broke out in the peripheries, and subsequent bailouts. Though there is no doubt the members states will follow the new fiscal compact rules, it is more likely the new treaty flounder on the same lines as the SGP.
Eurozone’s official fiscal projections have been biased upwards ever since the currency-bloc was established. While this happens with other countries as well, Europe’s problem has been worse. Fiscal rules are unlikely to constrain budget deficits if forecasts are biased, rather governments can argue that their tax collections and deficits will improve in later years. If this fails to materialize, they can counter the shortfalls were unexpected. Between 1999 and 2011, each time eurozone government forecasts went off the track, more optimistic projections followed. Governments decided to adjust their forecasts, but not policies.
The new fiscal rules based on cyclical terms, while desirable in macroeconomic terms, doesn’t address the problem of forecast bias. In fact it gives more alibis to governments as members can defend over-optimistic structural deficits as cyclical, thus exacerbating the problems. The difficulty in decomposing the structural versus cyclical fiscal position will be cited as the reason for deficit target shortfalls. It will be better if governments were lawfully bound to incorporate these targets in their budget plans.
Independent fiscal projection institutions can be established, and together with the cyclically adjusted fiscal-compact-target that the new treaties mandate, they can limit fiscal target biases. Things can get much worse, as demonstrated by the failure of the SGP, if corrective measures are not taken soon.
CURRENCY RATES OVERVIEW
GBP/EURO – 1.1856>
GBP/US$ – 1.5852>
GBP/CHF – 1.4756>
GBP/CAN$ – 1.5722>
GBP/AUS$ – 1.5003>
GBP/ZAR – 14.0068>
GBP/JPY – 141.06>
GBP/HKD – 12.2812>
GBP/NZD – 1.8816>
GBP/SEK – 10.2922 >
EUR: The shared-currency traded in a fairly narrow range against the US dollar yesterday due to lack of much data from Europe and the Martin Luther King Day in the US. The EUR/USD pair moved in a 20 point range while the eurozone finance ministers met to discuss Cyprus’s bailout and the aid programmes to the Portuguese, Spanish and Irish banks. Any comments from the meeting will be closely watched though any formal decision on Cyprus may not be forthcoming today even as the ECB President addresses the media early in the afternoon. The EUR/USD pair opens at 1.3350 this morning while the GBP/EUR pair has slipped lower to 1.1862.
USD: The GBP/USD pair didn’t move much either on Monday, trading within a 40 point range as economic data out of the UK was insignificant amid growing speculation that the impending MPC meeting minutes will reveal increased expectations of a fourth-quarter economic contraction. While the GBP/USD pair fell to a low of 1.5806 yesterday there’s big support at the 1.5800 level currently as the UK economic calendar gets busy today. We have the UK public sector net borrowing data out today along with the CBI industrial order expectations that will give clear indications about the state of the UK economy. Existing home sales data are due from the other side of the water though focus will largely remain on PM Cameron’s speech on the EU tomorrow and GDP numbers on Friday. The GBP/USD pair opens at 1.5840 this morning.
Have a great day!
