Mervyn King: Rate Cuts May Do More Harm Than Good

Mervyn King: Rate Cuts May Do More Harm Than Good

Good morning and welcome to today’s foreign exchange market commentary on Thursday, the 9th of August.

Whither low rates:

Bank of England Governor Mervyn King said further rate cuts may do more harm than good in yesterday’s inflation report. Indeed the 10-year interest rates in the UK, Germany and the US are hovering around the once unthinkable 1.5 percent for some time now, even though inflation-adjusted return has become negative. The rate on the Treasury Inflation Protected Securities or TIPS is now negative for 15 years. While rates can fall further in the short-tem, the situation becomes unsustainable in the long run.

One of the major reasons for today’s record low yield is the global savings spree, though witnessed across geographies for different reasons. The aging Japanese population needs to save for retirement while China holds bonds to avert a future banking crisis triggered by property crash. Meanwhile oil exporters like Saudi Arabia and United Arab Emirates want to save wealth aside as long the boom years last.

Another reason for low rates is the ongoing crisis since central banks brought down short-term rates to near zero to stimulate credit off-take. In normal times, loose monetary policies in the short-term push up long-term rates as investors start to recognise the inflationary effects of excess money supply. This has not happened in the current scenario as central banks have been able to convince markets that stimulus will be withdrawn before inflationary trends gather momentum.

The most important reason however, remains the fear of an imminent meltdown in Europe. This is the reason why investments by many companies have remained subdued despite the low interest-rate regime.

However, once the dust over Europe settles, which may not happen anytime soon, today’s unstable low-rate dynamics may unwind pretty quickly.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2652
GBP/US$ – 1.5672
GBP/CHF – 1.5207
GBP/CAN$ – 1.5571
GBP/AUS$ – 1.4782
GBP/ZAR – 12.6494
GBP/JPY – 123.03
GBP/HKD – 12.1578
GBP/NZD – 1.9232
GBP/SEK –  10.4692

EUR: The single-currency had a quiet day yesterday with the EUR/USD trading between the 1.2330 and 1.285 ranges. Greece was downgraded by S&P to CCC citing possible difficulty in securing further bailout money from the ECB and the EU which failed to surprise the markets. However, the week German industrial output number caught the markets by surprise, again highlighting the challenges the region faces. The German 10-year bond auction went off well with average yield trading at 1.42 even as ratings agency Fitch reaffirmed Germany’s AAA-stable outlook. The GBP/EUR pair meanwhile got a boost from Mervyn King after the BoE Governor hinted no further cuts in base rates even though he slashed UK growth projections to zero from the previous 0.8 percent. The GBP/EUR pair opens at 1.2680 today morning.

USD: The cable sold off yesterday before the Bank of England’s inflation report came out with the GBP/USD pair hitting a low of 1.5580. However Mervyn King painted a less gloomy picture than most had anticipated even though the central bank cut its growth forecast to zero from the earlier 0.8 percent. He then went on to say a further 0.25 percent rate cut will do more harm than good, suggesting a no further rate cuts in near future while hoping the economy will return to growth in the third quarter. The economic data calendar is light on the ground today with only the trade balance reading due in the morning. The GBP/USD pair opens the day at 1.5655.

 

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