Currency Union in upbeat mood

Currency Union in upbeat mood

Good morning and welcome to today’s foreign exchange market commentary on Friday, the 1st of February.

After three years of existential crisis, the currency union started 2013 on a surprisingly upbeat mood. Policymakers emphatically announced the worst is behind us and the war has been nearly won. And there is some basis for their claims; bond yields in Spain and Italy have significantly fallen. Stock markets have rallied while the currency has strengthened. Business confidence is slowly building up and the news reports of night-long negotiations in Brussels have virtually disappeared from the front pages.

The reality may nonetheless, could be very different. The first phase of the crisis, started off as a financial emergency, was essentially a collapse in confidence in the region’s markets, particularly in Ireland, Portugal and Greece. The second phase, consisting of economic and social collapse, will graver and far difficult to manage.

A banking or a financial crisis is easier to fix. All you need to do is print some notes and distribute it among the banks to solve the problem. That has been proven in 2008 in the US. The European Central Bank again proved it by supplying some cash through the banks’ backdoor in 2011 and ’12 with an express promise to print unlimited money.

But economic problems are far difficult to solve. Two big issues remain unresolved in the currency zone. The peripheral countries still remain uncompetitive against their northern neighbours in Europe. While bond yields have fallen, borrowing costs for the private sector remain prohibitively high in the periphery than in the north – say in Germany, making it far more expensive for companies to invest.

The effects are looking terrible. Spanish unemployment is already at 26 percent while in Greece it is 26.8 percent. An IMF forecast projects 1.7 percent growth for Spain till 2017, too small to make any dent on the unemployment rate. Italy is likely to join the group sooner than later.

The million dollar question is then, how far societies are willing to accept after they say they had enough? The Great Depression of the 1930s gives us some indication. Recent research suggests unemployment rate between 28 and 33 percent is the tipping point. So Greece and Spain are not far from the breaking point and unless they improve fast, they are likely to leave soon.

In such a scenario, markets will witness absolute chaos. Rally in European equities at the beginning of the year is quite common; in fact share prices have gone up significantly in 11 of the last 15 years. But as opposition mounts due to the social costs involved and the recession deepens due to ever increasing spending cuts, the rally will probably come to an end soon.

Don’t be fooled by the sudden calm on the western front. The real crisis may be just beginning to unfold, and it will be long before the war gets over.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.1638
GBP/US$ – 1.5856
GBP/CHF – 1.4423
GBP/CAN$ – 1.5828
GBP/AUS$ – 1.5245
GBP/ZAR – 14.1840
GBP/JPY – 146.06
GBP/HKD – 12.2935
GBP/NZD – 1.8814
GBP/SEK – 10.0270

EUR: Month end dollar selling ensured the greenback remained well bid against the euro yesterday and the EUR/USD pair rose 0.09 percent to 1.3583 and the disappointing German retail sales data was seemingly shrugged off. The common currency however found support after German unemployment fell unexpectedly in January for the first time in 10 months. The euro may struggle to make too much ground against the USD today as markets get ready for the all-important US non-farm payrolls data. The GBP/EUR pair opens at 1.1639 this morning.

USD: Cable edged higher against the greenback over the past 24 hours and the GBP/USD pair threatens to breach the 1.59 level due to mild short covering in GBP positions. Also higher-than-expected jobless claims in the last week dampened demand for the US unit. Traders and investors however are unlikely to take the GBP/USD pair above the 1.59 level ahead of today’s nonfarm payroll number. That being said, if UK manufacturing PMI, due in the morning, comes out better than expected, the GBP/USD pair may gain some momentum. The GBP/USD pair opens at 1.5877 this morning.

Have a great weekend!

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