Daily Currency Report

10th July 2009

MPC keeps base rate & asset purchase scheme unchanged

The Bank of England met yesterday and kept the base rate on hold at 0.5%. They also decided not to expand the asset purchase scheme at this time. This was somewhat of a surprise to the markets as many commentators thought they would expand the £125bn scheme by another £25bn bringing it to £150bn, which is the upper limit of what the Chancellor has authorised them to purchase at this time. In the statement following the meeting, the MPC said “The Committee expects that the announced programme will take another month to complete. The Committee will review the scale of the programme again at its August meeting, alongside its latest inflation projections.”The BoE is currently purchasing about £23bn of assets a month, and it indicates that it has another month before it has spent up to the max of £125bn under its current plan. Given that timeline, it’s surprising that they didn’t decide to sanction the “relatively”small extension of £25bn. It may mean, however, that the choice for the MPC now is to halt at £125bn or ask for permission to extend the programme beyond the current £150bn limit. The data indicates that the UK economy is about to start a recovery so it may be time to plan exit strategies from the current supportive measures rather than extend them further. However, the Bank of England remains concerned that the recovery (when it comes) will be weak and unsustainable. The Bank will take careful note of what the inflation projections are next month. In the last inflation report in May, the MPC stated that "under the assumptions that Bank Rate moves in line with market rates and the stock of purchased assets…reaches £125 billion, it is more likely than not that CPI inflation will be below the 2% inflation target in the medium term. On the other hand, on the assumption that Bank Rate is held constant (at 0.5% through the forecast horizon)…the risks of inflation being above or below target become more evenly balanced towards the two-year horizon”. If the August inflation forecasts are not materially different from this outlook, it would point to the Bank of England stopping purchases at £125bn but keeping the base rate at 0.5% for an extended period of time.

UK Gilt prices fell sharply after the meeting. 10 year gilt yields rose by between 15 and 20bps. US Treasuries and German bund prices also fell but yields did not rise by as much. 10yr Treasury yields rose by around 10bps while bund yields gained just a couple of bps. Sterling rose somewhat against the Euro, coming in from about £0.865 to around £0.86. Against the Dollar, Sterling rose from $1.60 yesterday to about $1.6250 currently. Equities prices were largely unchanged with most major indices making small gains on the day.

9th July 2009

MPC might expand their asset purchase scheme today

The IMF released new forecasts for the global economy yesterday, marginally revising downward the outlook for the current year but revising sharply up the outlook for 2010. The IMF now sees the world economy contracting by 1.4% this year compared to a forecast of -1.3% in their last world economic outlook in April. For next year, the IMF now sees global GDP growth of 2.5% up from 1.9% in April. The IMF forecast growth in the UK to be -4.2% this year and 0.2% next year. The report revises upwards the growth for all of the G8 economies next year as well as forecasting faster growth in the larger emerging economies. The IMF chief economist, Blanchard, said that “the forces pulling the economy down are decreasing in intensity…but the forces pulling the economy up are still weak”. A recovery is coming but it will be “sluggish”. The report reiterated that restoring financial sector health should be the main priority for policy makers. It also called on Governments to begin to plan how they will exit the current support measures, when the time is right, whilst keeping inflation low and repairing their public finances. However, the report did lend some support to further stimulus measures, if they were needed, in key economies. The risk of deflation is “small”and the outlook for global inflation is “expected to remain subdued through 2010, held back by significant excess capacity”. The relatively positive outlook from the IMF failed to spur on equities which finished the day lower in Europe and were virtually stagnant in the US. The S&P closed down 0.2% while the Dow was up 0.2%. The FTSE lost 1.1% while the Eurostoxx closed down 1.3%. The Euro is more or less unchanged against the Dollar and Sterling at around $1.39 and £0.865 respectively.

The MPC meets today and we do not expect them to change the base rate from its current level of 0.5%. The Bank of England has been cautious in its outlook for UK growth following the upturn in data over the past few months. King has said that the recovery from this recession will be a “long hard slog”and that a sustainable recovery was far from certain. The MPC has left to door open to further asset purchase beyond the £125bn it has authorised so far. We think there is every possibility of a £25bn expansion to the scheme today but we will have to wait until the minutes are released in a couple of weeks to get more insight into how the MPC thinks the asset purchase scheme is progressing.

8th July 2009

Foreign Currency

Sterling lost ground yesterday following much weaker than expected industrial production data. Total production fell by 0.6% in May reducing the three monthly rate to minus 1.8% (minus 12.3% year on year). The fall was most pronounced in energy related sectors, notably electricity generation, a factor which we expect to be partially reversed given the recent export of electricity to France, during a phase of French power plant shutdowns. There were, however, other negative aspects of the industrial production report including a significant decline in metals and machinery. The data is not compatible with recent survey evidence suggesting a marked slowdown in the rate of decline in industrial production in response to stock-rebuilding. It appears that the slowdown in the UK’s principal export market, the eurozone, is a more powerful force. Industrial output accounts for 18% of UK gross domestic product (GDP). Yesterday’s data does not auger well for the forthcoming UK advanced second quarter GDP data This prospect will exert a negative pull on sterling in the run up to GDP data on the 24th although there are numerous other factors that drive sterling’s value against other currencies. One key factor will be the Bank of England Governor’s comments following Thursday’s MPC meeting, which will provides clues as to the Bank of England current view of UK economic prospects.

Interest Rates

Period rates moved marginally lower in response to industrial production data. Short term the underlying trend in interest rates is marginally bullish. This applies to both short and long term interest rates. 3 month LIBOR continues to head lower and may well breach 1% before month end. Yesterday, 3 month LIBOR fixed at 1.10813%. There a still a surprising gap between euro and 3 month LIBOR. Despite the benchmark euro repo rate being ½% above UK bank rate, 3 month euro LIBOR fixed at close to 1% yesterday. The UK still has the highest 3 month LIBOR rate in G7.

Equities

Global equity markets remain in consolidation mode, although in recent weeks the path of individual indexes has often diverged on a daily or weekly basis. Until recently there was a strong correlation between major UK, US and European indexes, reflecting the increasing volume of worldwide sourcing and sales promotion.

Oil and other commodities

Brent crude (1 month forward) has fallen to a new lower trading range, circa $60 -67/ barrel, around $5 below the previous range. This reflects a re-assessment of global growth prospects. Global recovery is likely to be a gradual process.

7th July 2009

Foreign Exchange

The path of sterling in the coming days will be determined by today’s industrial production statistics and by Thursday’s trade statistics and MPC statement – plus the numerous international factors that drive sterling’s value in foreign exchange markets. Industrial production still accounts for a significant percentage of UK gross domestic product and has been badly hit by the recession due to severe UK de-stocking and the sharp downturn in the eurozone. Despite these factors, the previous month’s industrial production data showed a surprise upturn in both manufacturing and total industrial production. Today’s data, which relates to May, will indicate whether recent survey evidence of re-stocking has translated into higher production. The data, plus Thursday’s trade statistics will also provide evidence as to whether UK industry has been successful in diversifying export activity to the expanding economies.

Interest Rates

Period rates are broadly unchanged in the run up to Thursday’s MPC meeting. Yesterday, the Bank of England purchased £3.5bn of mostly long dated gilts, under its quantitative easing programme. The fall in the sterling trade weighted index yesterday, in the absence of key data, suggests that a significant percentage of sellers may well have been oversees holders, in line with previous reverse auctions. The Bank of England view is that overseas sales of gilts benefit UK industry by placing downward pressure on the currency which boosts UK export potential. Their view is that the programme has also led to longer term rates being lower than would otherwise be the case, a factor most pronounced in 10 year plus rates. Very long date rates are important from a macroeconomic viewpoint, given the large scale potential for major infrastructure projects in the UK. Very short date rates remain on a gradual downward trend. Yesterday, 3 month LIBOR fixed at 1.12375%.

Equities

European equities opened the week in slightly negative mode. This reflects a number of downbeat statements made in advance of the forthcoming G8 meeting. There is unease over the path of global economic recovery. We maintain our stance that the global recovery path will be uneven – a “ratchet recovery”. The key requirement for G8 is to reach agreement on the avoidance of protectionist measures, both direct and indirect.

Oil and other commodities

Brent crude (1 month forward) has remains in the region of $65/ barrel.

6th July 2009

Foreign Exchange

Sterling is somewhat weaker against major currencies, notably a strengthening US dollar. Friday’s UK survey data was marginally weaker than expected. The Chartered Institute of Purchasing and Supply / Market (PMI) service sector index fell by 0.1 in June to 51.6. One negative aspect of the survey was the 2 point fall in the new business component. The rising level of unemployment is at present limiting further progress in the sector, although if bank credit continues its gradual upward path, this will in due course boost both the service and industrial sectors of the economy. The road to UK economic recovery will be an uneven path. This week sees publication of two key UK statistical releases, industrial production and UK trade. Both could impact on sterling’s value in foreign exchange markets. Industrial production data will be especially significant since the previous months data showed an unexpected increase in both manufacturing and total industrial production. Recent survey evidence indicates that manufacturing industry is rebuilding stocks following an exceptionally sharp decline in first quarter 2009.

Interest Rates

Period rates are lower in response to the fall in the PMI survey business expectations component. The Bank of England MPC meets this week. There is a very high probability that bank rate will remain on hold for several months. There is a strong possibility that the MPC will endorse a further round of quantitative easing, which would necessitate large scale purchases of government and other high quality bonds. This factor is exerting a slight downward pressure on 5 year plus rates although the key driver of longer term rates will remain international factors. Short date rates continue on a downward path. On Friday, 3 month LIBOR fixed at 1.14125%. We predict that 3 month LIBOR will fall to circa 1% by early August, and then stabilize. Whilst bank credit is easing, the credit crunch will continue to exert an impact on money markets for the remainder of the year.

Equity Markets

European equity indexes closed the week in neutral mode. US equity markets were closed on Friday for the Independence Day holiday. This month is likely to see a moderate level of activity in equity markets, reflecting seasonal factors. Volume is expected to be much higher in September and October, when we expect to see the second leg of the equity market bull run, as evidence emerges of global economic recovery.

Oil and other commodities

Brent crude (1 month forward) has eased back to the region of $65/ barrel in response to a re-assessment of the speed of potential global economic recovery.