Currency Watch: A familiar feeling for the markets

It all started to feel very much like 2011 this week, with a poor peripheral bond auction in Europe causing deep slashes lower in world equity and currency markets.

In fact, so heavy was the fall on the FTSE that all the gains made since the turn of the year were wiped out; back to square one.

The country that represents the new bête noire for European policymakers is Spain and this bond auction was the first since the recent austerity bill.

The government only managed to get €2.6 billion of a prospective €3.5bn sold suggesting that rather than helping investor sentiment towards the country’s deficit reduction plan, the latest measures have heightened fears that further surprises may be somewhere down the road.

It will also be interesting to see how much of this issue was purchased by Spanish banks and how much was from international investors.

If the demand from in country banks for its own sovereign’s debts has fallen this could signal that Spanish banks are in need of more funding and a further liquidity operation or LTRO may be needed.

The falls were exacerbated by the Federal Reserve’s vacillation towards further asset purchases in the US on Tuesday night while Mario Draghi once again emphasised that the ECB’s liquidity operations were of a temporary measure.

In a brief opening statement following the ECB’s decision to hold rates at 1%, the governor emphasised the downside risks to growth in the Eurozone while saying that inflation was likely to remain elevated.

He tried to assuage recent criticism from German quarters by saying that the bank would pay attention to rises in food and oil prices which helped stabilise the euro through his speech.

That being said, GBP/EUR did trade above the 1.21 level, albeit briefly, for the first time in two months yesterday following the Spanish bond auction, poor German factory orders and a strong UK service sector reading.

UK PMI rose to 55.3 versus an expectation of 53.4. We think we can finally put to bed fears that the UK economy fell into recession in the first quarter and, revisions excepted, it looks like the UK economy grew at a rate of about 0.3/0.4% in Q1. So much for the OECD’s fears.

Obviously, this is only just enough to cancel out Q4’s negativity and therefore does not change the fact that the UK economy is still “bumping along the bottom” and that expansive gains in output are unlikely in coming quarters.

Jeremy Cook is chief economist at World First foreign exchange