A key theme in the past month has been the converging
growth trends we are seeing between the US and the slowing economies of Europe
and China. The US economic recovery continues to gather pace with improvements
in the labour market being particularly impressive, whilst the eurozone appears
to have entered what may be another painful recession.
Economic conditions in the UK sit somewhere in the middle
of those of the US and the eurozone. Recent data has revealed that the UK GDP
figure for the final quarter of 2011 was -0.3%. However, we still expect UK
growth to have returned to positive territory in the first three months of
2012. The release of the Q1 2012 GDP figure on April 24th will be a
crucial factor with regard to the Bank of England’s monetary policy outlook and
sterling’s performance this year.
Despite a building momentum within the US economy, the US
dollar has traded fairly softly for much of the past month. Nonetheless, we are
of the view that this equity strength will not be sustained (indeed equities
have suffered major losses this week) and safe-haven demand for the US dollar
will return to the fore. Dovish comments from US Federal Reserve Chairman Ben
Bernanke have also weighed on the US dollar, though the latest Fed meeting
minutes provided the market with a more optimistic tone.
News from the eurozone debt crisis was rather quieter in
March, aided by the ongoing impacts of the ECB’s cheap long-term loans (easing
liquidity and bond market pressures). A Greek default has been avoided but the
market remains suspicious that the worst of the crisis is yet to come.
March was a relatively calm month for the GBP/EUR pair,
with any drift away from the €1.1950 – €1.20 range proving temporary. There was
no further panic headlines from the eurozone, though concerns are building
around the situation in Spain and suspicions remain that Greece will once again
request further aid in the not too distant future. However, news out of the UK
economy has broadly been too shaky for sterling to push on and post fresh
multi-month highs against the single currency.
Looking back to the UK’s economic performance in
February, the UK manufacturing and services sector figures disappointed and
industrial production data for January also showed another monthly contraction,
though the construction sector provided an upside surprise. On the consumer
side, confidence remains at low levels, unemployment data was poor and at -0.8%
m/m UK retail sales were much worse than expected. To add to the month’s weaker
figures, the final UK GDP figure for the fourth quarter of 2011 was revised
down to -0.3%.
UK economy regaining some momentum
Amid these negative headlines, sterling found it tough to
test levels much higher than €1.20. However, GBP/EUR has made a robust start to
April, helped by a clean sweep of upside surprises within the growth updates
from the UK services, manufacturing and construction sectors. All three
sectors climbed to impressive levels of growth in March, which has firmed our
expectations that the UK economy will be able to avoid entering a technical
recession (contrary to the OECD latest estimates), if only marginally, by
posting a positive Q1 GDP figure on April 24th.
In light of February’s slowdown in UK growth, it is not
too surprising that two MPC policymakers (David Miles and Adam Posen) voted for
yet more quantitative easing at the rate-setting committee’s March meeting. The
ongoing possibility that the BoE could introduce further QE this year continues
to weigh on sterling’s ability to make further gains on the euro. However, the
latest set of UK growth figures suggest the economy has more momentum than
previously expected, which should keep the MPC doves at bay for the time being.
As ever, oil prices, ongoing UK austerity and renewed tensions in the eurozone
represent a very real threat to the UK’s recovery.
For much of March, the flow of negative debt crisis
headlines out of the eurozone was stemmed, largely thanks to the avoidance of a
Greek default. The ECB’s cheap loan operations (LTRO) have supported the
European banking system and eased pressures in the bond markets.
Nonetheless, economic data out of the region has
highlighted that it is not just debt but serious growth problems that the
region is facing. Eurozone unemployment levels are at more than a 14-year high.
The eurozone’s manufacturing and services sectors remain in contraction and
recent data has confirmed that the Q4 2011 GDP figure for the region was -0.3%.
We expect even worse quarterly figures to come this year.
The widening gap between conditions in Germany and the
eurozone periphery are underlining the ‘two-speed Europe’ that has developed.
However, whilst unemployment in Germany is at an all-time low and sentiment and
confidence surveys have generally been remarkably positive, all is not well in
the EU’s economic powerhouse. This was shown by the slowdown we are seeing in
Germany’s manufacturing, retail and services sectors.
Stalling debt crisis progress
The indecision of EU leaders with respect to solving the
debt crisis continues to weigh on the single currency. The latest development
from last week’s meeting of eurozone finance ministers has raised the available
bailout funds to €800bn, short of the €1trn that was hoped for and well short of
the necessary firewall should conditions in Spain and Italy deteriorate
further. The IMF will meet later this month to decide whether the latest
commitment from the EU’s leaders is deserving of a top-up from their side.
Unfortunately with the market now turning its focus from
Greece to Spain, the worst of the debt crisis may very well be yet to come.
Spain is already in recession and the severity of PM Rajoy’s latest austerity
package suggests the EU’s fourth-largest economy will not return to growth for
a long, long time. Crucially for the euro, it is becoming harder and harder for
Spain to regain the confidence of the financial markets. Spanish ten-year bond
yields are back on the rise above 5.5% and Italy’s are following a similar
trend. Concerns are clearly rising with regard to these two giant eurozone
GBP/EUR is currently trading at a one-month high above
€1.2050, helped by the latest UK growth figures and negative Spanish headlines.
We have seen GBP/EUR attempt to break north from €1.20 numerous times so far
this year and each time it has met stiff resistance. While risks continued to
be skewed to the upside for this pair, it may well require a fresh injection of
genuine eurozone panic to drive GBP/EUR to fresh 2012 highs. Sterling looks at
least very well supported above €1.20 moving forward.
The US dollar went through a particularly soft patch in
the past month. This has been somewhat surprising considering the closer
correlation that we have been seeing between the performance of the USD and
positive economic data this year. US economic data remains on an uptrend, as
shown by the strong US non-farm payrolls, retail sales and manufacturing sector
figures that have characterised the past month.
Bernanke remains cautious
A key factor behind the US dollar’s weakness in recent
weeks has been the ongoing cautious rhetoric coming from US Federal Reserve
Chairman Ben Bernanke. Bernanke refuses to celebrate the US economy’s upturn,
having seen similarly promising recoveries at the start of 2010 and 2011 both
fizzle out. With the market having incorrectly assumed that QE3 was off the
table earlier this year, ‘dollar bulls’ have had to endure a reality check. QE3
remains an option, one of several, which the Fed is willing to adopt should
conditions demand it. Bernanke aside, there are a range of views within the
Fed, which includes some notably optimistic assessments of the US recovery.
This was evident in the recent Fed meeting minutes, which demonstrated a more
positive assessment of US near-term economic prospects.
US economy to outperform
The eurozone situation and soaring oil prices continue to
trigger notes of caution from the Fed but it is becoming increasingly clear
that the US economy will be a major outperformer in 2012. UK growth may be
holding up fairly well in the face of some aggressive austerity measures,
particularly compared to its eurozone counterparts, but the pace of US growth
is likely to be significantly more impressive. The Fed is forecasting growth as
high as 2.5% this year, while the UK’s Office of Budget Responsibility has
recently forecast growth of 0.8% in 2012. The UK and US initial Q1 GDP
estimates are likely to remind the market of this divergence at the end of
Sterling reached a 2012 peak of $1.6050 recently, which
we believe will broadly represent a ‘top.’ We cannot see GBP/USD sustaining any
significant climb above the $1.60 level. We remain committed to a longer-term
dollar-positive outlook for 2012, which should take GBP/USD down to and
possibly below $1.50. Major safe-haven euro to US dollar flows will be required
for such a move, which is exactly what we expect. We see EUR/USD heading down
from current levels marginally above $1.30 down to $1.15, as the eurozone
recession and lack of a long-term solution to the debt crisis continue to weigh
on confidence in the single currency. A decline to levels below $1.57 remains
realistic in the coming weeks, as the dollar rebounds from its recent slump.
Caxton FX one month forecast:
GBP / EUR
|GBP / USD||1.57|
|EUR / USD||1.2975|
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