Good morning and welcome to today’s foreign exchange market commentary on Monday, the 18th of March.
Much of last month’s G 20-meeting discussions in Moscow revolved around the so-called currency war, where developing countries accused their advanced counterparts of unraveling a liquidity tsunami through their unconventional monetary policies. But another critical issue – that of fixed asset financing – was largely ignored, even though the gradual withdrawal of quantitative easing will require long-term financing in the global economy.
The collapse of Lehman Brothers in 2008 pushed up risk premia and triggered panic sale on either side of the Atlantic, weakening assets and threatening to initiate a credit crunch. Central banks stepped in to avoid asset fire sales and prevent a disorderly unraveling of financial institutions that could have brought down the euro or even triggered a new Great Depression.
While the fears of an economic meltdown have largely dissipated, the ultra-loose monetary policy in most advanced economies has resulted in liquidity spillover in other countries. The currencies of developing countries have significantly appreciated due to massive capital inflows, which have been unable to mitigate the effects due to economic constraints like high domestic inflation.
Unfortunately, a small portion of the excessive liquidity hence created, has been channelized in the small and medium enterprises that create most new jobs. Instead, crisis affected financial institutions have used the capital to rebuild and de-leverage their balance-sheets. Large corporations, on the other, chose to preserve cash and refinance their debts under favourable conditions. Consequently, job creation has stagnated while economic growth has remained lacklustre.
Many believe that the increase in asset prices and the eventual elimination of macro-financial tail risks will convince corporations to increase their exposure in new ventures. Unfortunately, such optimism may prove highly misplaced. A recent World Bank report, based on the analysis from various international organisations, has been quite downbeat.
To begin with, the regulatory reforms of financial institutions, which are yet to be implemented, will require banks and insurers to increase their capital base while shrinking the maturity transformation risk. This in turn is likely to make long-term bank borrowing more expensive.
Also the unwillingness of banks to lend is likely to persist well into future. Most banks on either side of Atlantic, particularly the ones in Europe that have traditionally financed large-scale infrastructure projects, are de-leveraging and rebuilding their capital buffers.
Rather than focusing on currency wars, global policy leaders should focus on maximising the benefits of liquidity generated through unconventional policy measures and use it to finance long-term assets. That will put the global economy on the recovery path.
CURRENCY RATES OVERVIEW
GBP/EURO – 1.1658
GBP/US$ – 1.5094
GBP/CHF – 1.4248
GBP/CAN$ – 1.5453
GBP/AUS$ – 1.4556
GBP/ZAR – 13.8931
GBP/JPY – 143.25
GBP/HKD – 11.7041
GBP/NZD – 1.8307
GBP/SEK – 9.7186
EUR: The single-currency firmed up on Friday on hopes that EU leaders will find means to boost growth in the euro region rather than solely focusing on austerity to reduce debt. The euro rallied to a session-high of $1.3107 before giving up some of the gains and ending the week at $1.3054 compared to $1.2910 on Thursday. Over the weekend the euro remained heavily sold off, dropping against most of its major trading partners following the news that the IMF and EU have approved a EUR 10-billion bailout to Cyprus and imposed one-off levy on all bank deposits in the region of 6.75-10 percent. The decision to impose levy as part of the bailout deal has been widely criticised and is yet to be approved by the Cypriot parliament. This reminds the markets about the fragile state of recovery in the euro region despite extraordinary efforts. Euro’s performance this week will depend on various data released from Germany and will give further indication about the pace of recovery in Europe’s strongest economy.
USD: The US dollar retreated against major rivals on Friday after data releases painted a mixed picture about the country’s recovery. Clearly, a weaker than expected consumer confidence reading weighed on the markets despite manufacturing showing signs of improvement. The University of Michigan-Thomson Reuters consumer confidence index fell to 71.8 in March, the lowest level since December 2011, from 77.6 in the previous month. A separate report showed industrial production in the US grew 0.7 percent month-on-month in February, well ahead of the 0.3 percent forecast by economists. The ICE dollar index, which measures the greenback’s strength against a basket of six global currencies, fell to 82.235 from 82.605 on Thursday on hopes the US Fed will not withdraw its stimulus measures any time soon. Sterling pushed above the 1.50 level after Governor King said the Bank of England didn’t try to actively devalue the currency, adding sterling is unlikely to weaken further. UK CPI data due for release on Tuesday will provide indications of potential BoE monetary policy as the number is expected to tick up to 2.8 percent. The GBP/USD pair has consolidated above the 1.50 level is trading at 1.5124.
Have a great day!