Currency watch: time for some cautious optimism?

We have now passed the two largest monetary policy signposts of 2012: the recent ECB and Federal Reserve meetings.

Before, they dominated market psychology like two juggernauts on the horizon; paralysing investors and keeping funds on the side-lines for fear of having the event risk clatter what little gains they’ve made this year.

Now, however, we know how they are focused and what they stand for. Their boxes are ticked and, certainly in the Fed’s case, their taps are open. It’s time for the market to go back to basics.

Before this crisis, central banks were never meant to be this front and centre. They’re not built for this kind of work and would rather happily sit in the market shade. With them in the wings, the market could trade happily on macroeconomic fundamentals and investor psychology and be done with it.

I think this is the market that we will start to return to in the coming days and weeks; the stabilisers are on the bike but dad is no longer running behind us with a tub of Savlon and an acre of sticking plasters.

The problem is the fundamentals remain weak and the actions of the central banks have taken away the relative lustre of those assets that performed well in the first half of the year. Those that benefited were the US dollar, German sovereign debt as well as that of the UK and, more pertinently to the readers of these updates, sterling.

With the decision by the ECB last week to go out and buy assets, once asked to do so, the safe-haven need for UK assets is likely to diminish. A bond auction last week from the Bank of England saw the highest yields in a good six months for 10 year money; they were still below 2%, a level at which most people would step over their own mother to be able to borrow, but the trend is definitely there.

Sterling is one of the more responsive currencies to its own data, much more so than the dollar, yen or euro. Now that the Olympic hangover has well and truly been shaken off we can step back and look at the UK economy and unfortunately be brought back to the reality that the worst is not over yet from an economic point of view.

Q3 data is likely to be the most impressive of this year’s lot; a combination of the late summer weather, the Olympics and a mathematical rebound from the very poor Jubilee period affected Q2. However, should they show signs of weakness the pressure will be felt not just in the City but also in Westminster.

Since returning from the summer recess, the political situation in the UK has seen a rise in calls for a coalition break-up and increasingly the prospect of some challenge to Cameron as leader of the Conservative party. We will have to see if anyone (Boris?) launches a serious challenge soon.

The bookies don’t have Cameron losing his grip until after 2015 nor the coalition breaking apart until the next election; “disengagement” as Vince Cable so memorably put it. Chatter around the subject, including Nadine Dorries’ badly portrayed “Kill Cameron” plan, will only serve to undermine the pound.

The forecast for the rest of the year is one of cautious optimism however. Risks remain everywhere but the relative increase in negative factors surrounding GBP does give us cause for concern.

Jeremy Cook is chief economist at World First foreign exchange