Europe is yet to consolidate

Europe is yet to consolidate

Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 14th of October.

Europe has taken some positive steps to resolve the crisis. The worst is however, far from over. There are still real possibilities of the union blowing up and things getting worse. When the global economy was recovering in 2010 from the shocks of 2008-09, the IMF projected global GDP growth will exceed 4 percent in 2010 and will accelerate to 4.5 percent through 2015. That proved far too optimistic and the latest report projects only 3.3 percent growth in 2012 and 3.6 percent in 2013.

There have been three reasons for missing the targets. The forecasts erred in estimating fiscal multipliers, neglected the world trade multiplier effect and failed to recognise the time needed for economic recovery.

Out of the three, fiscal multipliers were grossly underestimated and had a direct bearing on the UK growth forecasts. The IMF forecast of nearly 3 percent growth rate in 2012-13 was widely off the mark and this costly divergence could be attributed to the benign view of fiscal consolidation that the IMF assumed.

Similarly, the peripheries of Greece, Ireland, Portugal, Spain and Italy, have performed significantly worse than projected due to spending cuts and tax hikes. For example, Portugal’s economy was expected to grow by 1 percent in 2012; instead it will contract by a painful three percent.

The world trade multiplier helps explain why the growth slowdown gained pace. When an economy weakens, its imports fall, thus impacting exports from others. Weak global trade has almost stagnated exports over the past six months, with Europe being at the centre. The once popular notion that exports will provide an escape route from the crisis has fallen flat. This has been most visible in Germany. Berlin used the China route to avoid a deceleration. But as China shows signs of cooling, German GDP forecasts have been halved now.

In good times, a country’s growth momentum drives global expansion. However, this effect is reversed in bad times. This subsequently multiplies as trade becomes more interconnected, affecting growth universally. The failure to recognise this aspect, coupled with policy errors on the part of individual countries, runs the risk of damaging economies seriously across the world.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2476
GBP/US$ – 1.5879
GBP/CHF – 1.5032
GBP/CAN$ – 1.5896
GBP/AUS$ – 1.5205
GBP/ZAR – 13.9312
GBP/JPY – 126.92
GBP/HKD – 12.3132
GBP/NZD – 1.9441
GBP/SEK – 10.7510

EUR: The euro continues to hover around a two-month low against the dollar yesterday as uncertainty over Greece and weak German economic data diminished risk appetite. The EUR/USD pair bounced off the day’s low of 1.2661 following reports that Greece has successfully auctioned EUR 5 billion in 4- and 13-week T-bills to redeem debts maturing on Friday. The single currency maintained its momentum against the US dollar to open at 1.2730 this morning despite German ZEW economic confidence printing lower at -15.7 in November. German newspaper Bild Zeitung in a report claimed Berlin could bundle aid money worth EUR 44 billion once the disbursement mechanics are finalised with Athens. This has strengthened the euro against the cable and the GBP/EUR pair opens at 1.2477 this morning.

USD: Higher than anticipated UK inflation pushed the pound higher against the greenback yesterday and the GBP/USD hit a high of 1.5915. October CPI reading came in at 2.7 percent versus 2.2 percent in September and well above the forecast 2.3 percent. However, sterling gave away the gains by afternoon and the GBP/USD pair closed 1.5877 following public disagreements between the IMF and Euro-group leaders over Greek debt restructuring. We have the producer price index, core retail sales and advanced retail sales data due from the other side of the pond today. GBP/USD opens at 1.5890 today morning.

Have a great day!

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