Currency watch: Major markets under the cosh

One of the most common questions I get from clients is: “How can the euro stay so strong versus its competitors?” Simply put, the euro isn’t plummeting as it is not the only economy in trouble at the moment; the US is hurtling towards a double-dip, while the UK economy is also circling the drain.

The euro is also able to benefit from having reserve currency status and when traders switch out of the US dollar, for example when they are seeking a little more risk in their portfolio, then it is the euro that they are moving into.

We also have to remember that the currency markets are an indicator of future interest rate moves and money will always flow to where there is a greater yield. With the likelihood that the European Central Bank will raise rates in July to 1.5%, while it looks likely that the Bank of England will hold rates until the early part of 2012, then those flows will remain.

Sterling is still under pressure from domestic concerns after the Bank of England hinted that further quantitative easing would be needed to ensure that the UK economy doesn’t slip back into recession.

The Monetary Policy Committee is worried about consumer spending and naturally with fears of growth comes the belief that further asset purchases may be needed.

The committee was always going to take on a more dovish lean since the departure of arch-hawk Andrew Sentence anyway. We did get a hint of this from committee member Paul Fisher on Tuesday when he said that quantitative easing “is still very much on the table as one of our potential policy actions” and, although it may seem strange given food and energy prices are rocketing at the moment, certain members of the MPC are more fearful of deflation than inflation at the moment; that a constantly weak demand picture will keep growth below its averages and expectations.

So the pound slipped and those holding on for a rate increase in August have reappraised their views in light of this. Our forecast landscape remains stable at a February 2012 rate rise, although some believe that August 2012 is more likely.

Jeremy Cook, chief economist at World First foreign exchange, 24.06.2011